Keysight Technologies, Inc. — Q2 FY2023 Form 10-Q
Reporting period: Three and six months ended April 30, 2023; fiscal year ends October 31. Financial statements are unaudited. Amounts are in millions of dollars except per-share data and percentages.
Business context
Keysight provides electronic design and test products, software, and related services to communications, networking, electronics, aerospace, defense, government, and industrial markets. It reports two segments: Communications Solutions Group (CSG) and Electronic Industrial Solutions Group (EISG).
Financial performance
| Metric | Q2 FY2023 | Q2 FY2022 | Six months FY2023 | Six months FY2022 |
|---|---|---|---|---|
| Revenue | $1,390 | $1,351 | $2,771 | $2,601 |
| Gross margin | 65.4% | 63.6% | 64.7% | 63.9% |
| Operating income | $354 | $327 | $676 | $598 |
| Operating margin | 25.4% | 24.2% | 24.4% | 23.0% |
| Net income | $283 | $258 | $543 | $487 |
| Diluted EPS | $1.58 | $1.41 | $3.02 | $2.65 |
Q2 revenue rose 3% year over year; six-month revenue rose 7%. Product revenue was $1,108 and services and other revenue was $282 in Q2. The reported presentation was reclassified beginning in FY2023, moving certain bundled-license and technical-support revenue and costs from products to services; total revenue and earnings were unchanged.
- Segments: Q2 CSG revenue fell 3% to $937, while EISG revenue rose 17% to $453. For the first six months, CSG revenue increased 2% to $1,876 and EISG increased 18% to $895.
- Orders: Orders declined 10% in Q2 and 11% for the first six months year over year. Management cited declines in Asia Pacific and the Americas, partly offset by Europe.
- Cash flow: Six-month operating cash flow was $789, versus $522 a year earlier. Capital expenditures were $113, implying operating cash flow less capital expenditures of $676, compared with $427 in the prior period. The 2023 operating cash flow included $107 of proceeds from terminating interest-rate swaps.
- Balance sheet and liquidity: At April 30, cash and cash equivalents were $2,498; current assets were $4,764 and current liabilities $1,422. Total debt was $1,793 carrying value ($1,800 face value), with no revolver borrowings. The $750 revolving credit facility expires in July 2026. Cash, cash equivalents, and restricted cash totaled $2,514.
- Other balances: Inventory was $948, up from $858 at October 31, 2022, primarily reflecting supply-protection stock build and higher demo inventory. Current and long-term deferred revenue totaled $790.
Changes, outlook, and management commentary
- Gross-margin improvement reflected price increases and favorable mix, partly offset by higher material costs. Management attributed higher net income to revenue and interest-income growth, partly offset by higher income taxes and operating expenses.
- Management described moderated demand, particularly across the communications ecosystem, as customers manage spending amid macroeconomic and post-pandemic uncertainty. It cited ongoing investment opportunities in 5G/6G, automotive mobility, industrial IoT, semiconductor technologies, and defense modernization.
- No specific revenue or earnings guidance is provided in the supplied filing text. Management expects approximately $230 of FY2023 capital spending, primarily for capacity expansion and technology, and said available cash, operating cash generation, and access to capital and credit should meet foreseeable needs.
- Q2 effective tax rate was 21.8%, compared with 16.1% a year earlier; the six-month rates were 21.6% and 14.8%. The increase included U.S. R&D expenditure capitalization under tax law and discrete tax items. Singapore and Malaysia tax incentives reduced the six-month tax provision by $49; renewal is due in 2024 and 2025, respectively.
- Keysight acquired Cliosoft for approximately $85 net of cash acquired, adding electronic-design-automation data and IP-management tools. The company recorded preliminary acquisition goodwill and intangible assets of $57 and $56, respectively.
- The board authorized a new $1,500 stock-repurchase program in March 2023, replacing the prior authorization. Six-month repurchases were $125, versus $495 in the prior-year period.
Risks, contingencies, and unusual items
- Management highlighted macroeconomic uncertainty, inflation, slowing or delayed customer demand, supply constraints, inventory exposure, geopolitical tensions, trade restrictions, and foreign-exchange movements. It noted that demand has moderated in communications.
- Centripetal Networks has patent-infringement proceedings against Keysight in the U.S., Germany, and the International Trade Commission. Keysight denies the allegations and is defending the cases; an adverse outcome could involve damages or injunctive relief.
- Under a 2021 U.S. export-control consent agreement, Keysight was assessed a $6.6 penalty, with $2.5 suspended for compliance remediation. It had paid $2.1; the company says qualifying compliance spending satisfied the suspended portion.
- A Malaysian tax audit concerning fiscal 2008 remains under appeal. Prior appeals were unsuccessful; a Court of Appeal hearing occurred in April 2023, with a further hearing scheduled for July 2023. Management stated it did not expect current examinations to materially affect consolidated statements, while noting outcomes remain uncertain.
- Other watch items include renewal of tax incentives, potential changes from U.S. and OECD minimum-tax rules, cybersecurity and intellectual-property risks, and exposure to international trade controls. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether order declines translate into weaker revenue, especially in commercial communications, and how customer spending develops by region.
- Whether gross-margin gains and operating-margin improvement persist as material costs, operating expenses, and demand conditions change.
- How much operating cash flow is recurring after considering the $107 swap-termination proceeds and working-capital movements.
- Inventory levels and supply commitments relative to actual demand, as inventory increased during the six-month period.
- Potential tax-rate effects from the Singapore and Malaysia incentive renewals, R&D capitalization, and the Malaysian tax appeal.
- Developments in the Centripetal litigation and the execution and returns of the Cliosoft acquisition and new repurchase authorization.