Keysight Technologies, Inc. — Q1 FY2018 Form 10-Q
Reporting period: Three months ended January 31, 2018; balance-sheet figures are as of January 31, 2018, compared with October 31, 2017. Keysight provides electronic design and test solutions and, following its 2017 Ixia acquisition, network testing, visibility, and security solutions.
Financial performance
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Orders | $964 million | $695 million | Up 39% (up 37% excluding currency); acquisitions contributed 22 percentage points |
| Net revenue | $837 million | $726 million | Up 15% (up 14% excluding currency); acquisitions contributed about 16 percentage points |
| Gross margin | 51.1% | 55.7% | Down 4.6 percentage points |
| Operating income (loss) | $(5) million | $162 million | Operating margin declined to (0.6)% from 22.4% |
| Net income | $94 million | $109 million | Down $15 million |
| Diluted EPS | $0.50 | $0.63 | Down $0.13 |
| Cash from operations | $171 million | $115 million | Up $56 million |
Product revenue was $684 million, up 13%; services and other revenue was $153 million, up 27%. The filing attributes lower gross margin to acquisition-related amortization, wildfire costs, higher warranty expense, and inventory charges, partly offset by favorable mix. Operating expenses also rose, including R&D of $146 million (up 35%) and SG&A of $289 million (up 36%).
Operating cash flow benefited from working-capital timing, including reduced working capital associated with wildfire recovery, which Keysight expected to reverse during the rest of the first half. Investing cash outflow was $27 million, including $24 million in capital expenditures; financing cash inflow was $9 million. Cash and cash equivalents ended at $980 million, including approximately $923 million held outside the U.S.
Current assets were $2.275 billion and current liabilities $886 million. Total debt was approximately $2.048 billion, including $20 million current and $2.028 billion long-term; cash less debt was approximately $1.068 billion. Keysight had no revolving-facility borrowings at quarter-end and reported compliance with its covenants. The $260 million term-loan balance at quarter-end was repaid in February 2018.
Changes, segments, and unusual items
- Growth in total revenue included the contribution of acquired businesses. Communications Solutions Group revenue declined 3% to $420 million, largely due to wildfire disruption; Electronic Industrial Solutions Group revenue rose 6% to $203 million; Services Solutions Group revenue rose 6% to $106 million. Ixia Solutions Group contributed $108 million of consolidated net revenue; the segment presentation separately shows $127 million including $19 million of acquisition-related amortization balances.
- Net income included a $117 million income tax benefit, principally related to the U.S. Tax Cuts and Jobs Act. The reported effective tax rate was a benefit of 515.8%; management estimated a 7.5% annual effective tax expense rate excluding discrete items. The tax-law accounting remained provisional, and the company had not completed its assessment of certain provisions, including GILTI.
- Prior-year results included a $68 million Japan pension settlement gain and an $8 million land-sale gain. Current-period costs included $18 million of Ixia acquisition and integration costs, higher acquisition-related amortization, and $7 million of net wildfire-related costs.
- Wildfires affected the Santa Rosa headquarters and disrupted revenue seasonality. Keysight said recovery was progressing faster than initially expected but could extend at least into the third fiscal quarter. It estimated total insurance recovery of $80 million to $110 million; $23 million was receivable at quarter-end and $10 million of wildfire insurance proceeds had been received by then.
- Management cited investment in R&D and acquisitions as positioning the company for growth and emphasized operational efficiency. No quantified revenue or earnings guidance was provided in the supplied filing text. Planned FY2018 capital expenditures were approximately $130 million, including $20 million to $30 million for wildfire recovery, expected to be covered by insurance.
Risks and contingencies
Key disclosed risks include uncertain and cyclical customer demand, competition and rapid technology change, supply-chain and outsourced-manufacturing dependence, foreign-exchange exposure, and successful integration of Ixia and other acquisitions. The filing also highlights debt and covenant risks, cybersecurity and other operational disruptions, tax-law uncertainty and tax audits, environmental matters, and potential catastrophic events. Keysight was appealing a Malaysian tax assessment relating to 2008; it had paid $68 million in taxes and penalties in 2017 and disputed the assessment. Management stated that pending legal matters were not then believed likely to have a material impact. The filing also notes that wildfire insurance reimbursement timing may differ from the timing of costs.
Investor verification points
- Separate underlying demand from acquired growth: acquisitions contributed 16 percentage points of revenue growth, while orders rose 39% and revenue rose 15% year over year.
- Monitor wildfire recovery, Communications Solutions Group performance, and the timing and collectability of the estimated $80 million to $110 million insurance recovery.
- Assess recurring profitability after the unusually large provisional tax benefit and the prior-year pension and land-sale gains; reported operating loss and margins reflect substantial acquisition and other costs.
- Verify final Tax Act accounting, including GILTI and potential adjustments to the provisional $117 million benefit, and follow the Malaysian tax appeal.
- Track debt after the February repayment of the $260 million term loan, cash availability given the large foreign-held balance, and planned capital spending.