Keysight Technologies, Inc. — Q2 FY2016 Form 10-Q
Reporting period: Three and six months ended April 30, 2016; fiscal year ends October 31. Amounts are in millions of dollars, except per-share data. Comparisons are with the corresponding 2015 periods unless noted.
Business context and results
Keysight provides electronic design and test instruments, software and related services to communications, aerospace and defense, and industrial, computer and semiconductor markets. Its reportable segments are Measurement Solutions and Customer Support and Services. The Anite acquisition, completed in August 2015, expanded wireless test and software offerings; its results are included from the acquisition date.
| Metric | Q2 FY2016 | Q2 FY2015 | Six months FY2016 | Six months FY2015 |
|---|---|---|---|---|
| Orders | $761 | $697 | $1,440 | $1,388 |
| Net revenue | $731 | $740 | $1,452 | $1,441 |
| Gross margin | 55.5% | 56.3% | 54.9% | 55.5% |
| Operating income | $95 | $133 | $193 | $220 |
| Operating margin | 13.0% | 18.0% | 13.3% | 15.3% |
| Net income | $88 | $96 | $152 | $166 |
| Diluted EPS | $0.51 | $0.56 | $0.88 | $0.97 |
Cash flow, debt and liquidity
- Six-month operating cash flow was $209, up from $160. Investing activities used $62, including $62 of capital expenditures; financing activities used $16. Cash increased $137 to $620.
- Management expects approximately $100 of capital expenditures for FY2016 and about $19 of additional contributions to non-U.S. defined benefit plans during the remainder of the year.
- At April 30, cash and cash equivalents were $620, including approximately $410 held outside the U.S. Current assets were $1,737 and current liabilities $652.
- Long-term debt was $1,100, principally $499 of 3.30% notes due 2019 and $600 of 4.55% notes due 2024. The $450 unsecured revolving credit facility had no borrowings; the company reported covenant compliance. A £25 overdraft facility also had no borrowings and expires July 31, 2016.
- Keysight repurchased 1.6 million shares during the six months under a newly authorized $200 repurchase program. The filing reports $40 of cash paid and $42 of treasury stock recorded.
Material changes and management commentary
- Orders rose 9% in the quarter and 4% year to date; acquisitions contributed 8 and 7 percentage points, respectively. Currency reduced each comparison by 1 percentage point.
- Revenue fell 1% in Q2 and rose 1% for the six months (currency-adjusted: down 1% and up 2%). Acquisition contributions were offset by weakness in communications revenue excluding Anite, particularly smartphone supply-chain weakness and customer restructuring/consolidation.
- Product revenue declined 3% in Q2 and 1% year to date; services and other revenue grew 8% in both periods. Customer Support and Services revenue declined 5% in Q2 and 3% year to date, while its operating income fell to $11 from $18 in Q2 and to $24 from $32 for six months.
- Operating income and margins declined despite higher orders, principally reflecting acquisition-related amortization and fair-value adjustments, higher people and integration costs, and softer revenue. Consolidated R&D spending increased 12% in Q2 and 13% year to date, primarily due to Anite.
- Management estimates long-term market growth of 2%–3%, but says near-term macroeconomic indicators are mixed. It expects aerospace and defense to grow slowly and steadily; industrial, computer and semiconductor markets to remain soft; and communications markets to remain soft amid cautious wireless R&D and manufacturing spending.
Outlook, unusual items and risks
- Management expects $7–$12 of additional non-recurring separation and related costs through the rest of FY2016, primarily for infrastructure resizing and optimization.
- The Q2 tax provision was a $1 benefit, with a 1.1% effective tax benefit rate, attributed to tax planning. The estimated annual effective tax rate was 11% including discrete items and 12% excluding them. Tax incentives reduced the six-month provision by $17; the Singapore incentive is due for renewal in FY2024.
- The six-month results included a $10 gain on sale of a U.K. land tract. The company expects a further land transfer and payment under the existing contract in November 2016.
- Key disclosed risks include uncertain global demand and market cyclicality; customer and supplier concentration or consolidation; product obsolescence and competition; execution and integration of acquisitions; foreign-exchange exposure; outsourcing and supply-chain disruptions; cybersecurity and IT interruptions; tax examinations and separation-related tax liabilities; pension funding; and debt and liquidity requirements.
- Keysight reported no pending legal matters it believed were reasonably possible of having a material impact. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether order growth converts into organic revenue growth, given the material contribution from acquisitions and weakness in communications excluding Anite.
- Whether operating margins stabilize as acquisition integration and amortization costs continue, and whether Customer Support and Services capacity investments improve profitability.
- The durability of the unusually low tax rate, tax incentives, and unresolved allocation discussions with Agilent regarding deferred tax liabilities on foreign earnings.
- Use of the remaining authorization under the $200 repurchase program, including the reported difference between cash paid and treasury-stock accounting value.
- Cash availability for U.S. needs given that approximately $410 was held abroad, potential repatriation taxes, debt maturities, and the expected FY2016 capital and pension spending.
- Acquisition integration and purchase-accounting estimates, including goodwill and intangible asset balances and future amortization.