Keysight Technologies, Inc. — Q2 FY2018 Form 10-Q
Reporting period: Three and six months ended April 30, 2018; fiscal year ends October 31. Keysight provides electronic design and test instruments, software and services, plus network testing, visibility and security solutions through Ixia, acquired in April 2017. Figures are unaudited and in U.S. dollars.
Financial performance
| Metric | Three months ended Apr. 30, 2018 | Year-over-year | Six months ended Apr. 30, 2018 | Year-over-year |
|---|---|---|---|---|
| Orders | $987 million | +23% (+20% currency-adjusted) | $1.951 billion | +30% (+28% currency-adjusted) |
| Revenue | $990 million | +31% (+29% currency-adjusted) | $1.827 billion | +24% (+21% currency-adjusted) |
| Gross margin | 54.9% | +0.1 percentage point | 53.1% | -2.1 percentage points |
| Operating income / margin | $100 million / 10.1% | $42 million / 5.5% in 2017 | $95 million / 5.2% | $204 million / 13.8% in 2017 |
| Net income | $64 million | $49 million in 2017 | $158 million | Unchanged |
| Diluted EPS | $0.34 | $0.27 in 2017 | $0.83 | $0.90 in 2017 |
| Operating cash flow | Not separately provided for the quarter | $282 million | $164 million in 2017 |
Product revenue was $830 million and services and other revenue was $160 million in Q2. Acquisitions contributed approximately 10 percentage points of Q2 revenue growth and 13 points for the first half; Ixia comparisons are affected by its inclusion for only 13 days in the prior-year period. Management cited broad strength, led by Communications Solutions, as well as growth in Electronic Industrial and Services Solutions. First-half operating margin fell principally because the prior year included a $68 million Japan pension settlement gain and an $8 million land-sale gain, while current-period acquisition amortization, integration costs and people-related costs increased.
Cash, debt and liquidity
Cash and cash equivalents were $784 million at April 30, 2018, versus $818 million at October 31, 2017; approximately $729 million was held outside the United States. First-half operating cash flow was $282 million. Capital expenditures were $58 million, implying cash flow after capital expenditures of approximately $224 million. Investing activities used $49 million; financing activities used $271 million, mainly reflecting repayment of the term loan and share repurchases.
Total debt was $1.789 billion, comprising senior notes due 2019, 2024 and 2027; the $260 million term-loan balance was repaid in February 2018. There were no revolver borrowings at period-end; the company had a $450 million revolving facility expiring in 2022. Cash less reported debt was approximately negative $1.005 billion. Management believed available cash, operating cash generation and access to capital and credit would meet liquidity needs for at least 12 months.
Outlook, commentary and notable items
- No specific revenue or earnings forecast is provided. Management said R&D investment and acquisitions position Keysight for growth, with a focus on next-generation digital and electronic technologies and operational efficiency.
- Management expected full recovery from wildfire-related shipment disruption in the second half of FY2018. It estimated insurance recovery of $90 million to $115 million; $40 million had been received and a $25 million receivable was recorded at April 30. Timing of recovery may differ from costs, and potential excess insurance gains were not recognized.
- FY2018 capital spending was expected to be approximately $130 million, including $25 million to $35 million for wildfire recovery, expected to be insured. The company expected $17 million of non-U.S. defined-benefit pension contributions for the remainder of the year.
- The first-half income-tax benefit was $98 million, including a provisional $103 million discrete benefit from U.S. tax-law changes. The estimate remained subject to revision; the company had not completed its assessment of certain Tax Act provisions, including GILTI. The estimated annual effective tax rate excluding discrete items was 7.9%.
- Ixia integration work on systems, processes and site consolidation took longer than expected and weighed on its Q2 results; management said many issues had been resolved.
- The company authorized a new $350 million share-repurchase program and repurchased 773,352 shares for $40 million during the first half. It reported no pending legal matters believed reasonably likely to have a material impact.
Key risks and contingencies
Risks highlighted include uncertain and cyclical customer demand, competition and rapid technology change, supply-chain and contract-manufacturing constraints, international and currency exposure, acquisition integration, cybersecurity and IT disruption, and potential catastrophic events. Tax examinations and changes in tax rules may affect results. Keysight had paid $68 million in 2017 in tax and penalties related to a Malaysian tax assessment and was appealing it. It also noted that future pension funding needs could vary. Management reported disclosure controls as effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- How much reported growth reflects underlying demand versus acquisitions and foreign-currency movements, particularly for Ixia.
- Whether revenue growth converts into sustained operating-margin improvement as acquisition amortization and integration costs continue.
- The final tax effects of the Tax Act and the outcome of the Malaysian tax appeal.
- The timing and collectability of wildfire insurance recoveries, and whether expected recoveries cover total costs.
- Debt service, cash deployment and remaining authorization under the share-repurchase program.
- Whether Ixia integration issues remain resolved and whether management’s second-half wildfire recovery expectation is achieved.