Keysight Technologies, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended July 31, 2019. Amounts are in millions of dollars except per-share data. The financial statements are unaudited.
Business context and reporting period
Keysight provides electronic design and test products, software, and services to communications, networking, aerospace, defense, government, and electronics customers. Its three reporting segments are Communications Solutions Group (CSG), Electronic Industrial Solutions Group (EISG), and Ixia Solutions Group. The company reorganized service reporting in fiscal 2019; prior-period segment results were recast for comparison.
Financial performance and liquidity
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net revenue | $1,087 | $1,004 | $3,183 | $2,831 |
| Income from operations | $197 | $117 | $503 | $186 |
| Net income | $159 | $121 | $426 | $279 |
| Diluted EPS | $0.83 | $0.63 | $2.23 | $1.46 |
| Gross margin | 59.1% | 56.0% | 58.7% | 53.9% |
| Operating margin | 18.2% | 11.7% | 15.8% | 6.6% |
| Orders | $1,110 | $1,007 | $3,247 | $2,958 |
- Reported revenue rose 8% in Q3 and 12% for the nine months; orders increased 10% in both periods. Management reported revenue growth excluding currency, acquisitions, and divestitures of 9% and 14%, respectively.
- Q3 product revenue was $904, up 7%; services and other revenue was $183, up 13%. Nine-month product revenue was $2,652, up 13%, and services and other was $531, up 12%.
- Q3 segment revenue: CSG $683 (up 13%), EISG $295 (up 3%), and Ixia $110 (down 7%). For nine months, revenue was CSG $1,982 (up 15%), EISG $851 (up 7%), and Ixia $357 (up 6%).
- Cash from operations was $735 for nine months, compared with $320 a year earlier. Investing used $169, including $90 for the Prisma acquisition net of cash acquired and $90 of capital expenditures. Financing used $91, including $130 of share repurchases.
- At July 31, cash and cash equivalents were $1,394; cash, cash equivalents, and restricted cash totaled $1,396. Total debt was $1,792 ($500 current and $1,292 long-term), versus $1,790 at October 31, 2018. The $450 revolving credit facility had no borrowings outstanding. Current assets were $2,935 and current liabilities $1,432.
- Cash and cash equivalents increased from $913 at October 31, 2018; inventory increased to $696 from $619. Total assets were $6,348 and stockholders’ equity $2,938. Approximately $967 of cash, cash equivalents, and restricted cash was held outside the U.S.
Material changes versus the prior comparable period
- Higher revenue volume, favorable mix, a differentiated solutions portfolio, and lower warranty costs lifted gross margins. Operating income also benefited from lower acquisition/integration and restructuring costs; higher people-related costs and R&D investment partly offset the gains.
- R&D expense increased 9% in Q3 and 10% for nine months; SG&A decreased 4% and 3%, respectively. Q3 Ixia revenue and operating margin weakened, with management citing softness in network test solutions and higher infrastructure-cost allocations.
- Prior-year tax benefits materially affect the comparison: the nine months ended July 31, 2018 included a $106 income-tax benefit, primarily a $109 benefit from U.S. tax-law changes. In 2019, income-tax expense was $86 for nine months, including a $32 million discrete benefit. The 2019 nine-month effective tax rate was 16.9%, versus a 61.3% benefit rate in 2018.
- Keysight adopted ASC 606 on November 1, 2018. Adoption increased nine-month 2019 reported revenue by $15 and net income by $9 versus amounts calculated under the prior standard; quarterly revenue was $2 lower. Comparative periods were not restated.
Outlook, management commentary, risks, and unusual items
- Management expressed confidence in its end markets and growth opportunities, including 5G and other emerging technologies, while noting short-term uncertainty and monitoring trade, tariffs, and monetary and fiscal policies. It stated that it would comply with U.S. export controls regarding China. No specific revenue or earnings guidance was provided in the filing.
- Management expected fiscal 2019 capital spending of approximately $130 and additional wildfire-related insurance proceeds of $35–$40 during fiscal 2019. The company said cash, operating cash generation, and access to capital and credit would meet liquidity needs for at least the next 12 months.
- CSG growth was led by commercial communications, including 5G R&D and next-generation 400-gigabit Ethernet testing. EISG grew modestly; Q3 semiconductor-measurement weakness partly offset strength in general electronics, automotive, and energy. Ixia’s Q3 decline reflected network-test softness.
- Keysight acquired Prisma Telecom Testing for $90 net of $56 cash acquired, adding radio-access-network testing capabilities intended to extend its 5G portfolio. The company also announced a subsequent organizational change to manage Ixia within CSG, expected to be completed in fiscal Q1 2020.
- A new $500 stock-repurchase authorization replaced the prior program; Keysight repurchased $130 of shares during the nine months. It did not declare a dividend.
- Risks highlighted include trade restrictions and tariffs, especially involving China; cyclical and uncertain customer demand; rapid technology change and returns on R&D; supply-chain and contract-manufacturer dependence; foreign exchange; cybersecurity; acquisitions and integration; and tax exposures. Malaysia continued to audit the 2008 tax year; Keysight had paid $68 of tax and penalties in 2017 and was appealing the assessment. Management reported no pending legal matters it believed probable to have a material impact.
- The filing identifies $312 of remaining performance obligations at July 31, excluding contracts with an original duration of one year or less; expected recognition was 13% during the rest of 2019, 39% in 2020, and 48% thereafter.
Most important facts for investors to verify
- Whether order growth converts to revenue, particularly in commercial communications and 5G, and whether Ixia’s network-test business stabilizes.
- How much margin improvement is sustainable after accounting for product mix, warranty costs, R&D and people costs, and acquisition-related expenses.
- Cash-flow quality and working-capital movements, including inventory growth, deferred revenue, and the timing of tax and insurance-related cash flows.
- Debt maturities and service requirements, the pace of repurchases under the $500 authorization, and cash availability across jurisdictions.
- The effect of ASC 606 on comparability, the estimated fiscal 2019 tax rate and discrete tax items, and the outcome of the Malaysia tax appeal.
- Whether the stated capital-spending and wildfire-insurance expectations are achieved, and the effects of trade, export-control, and other macroeconomic risks.