Keysight Technologies, Inc. — Q3 FY2017 Form 10-Q
Reporting period: Fiscal quarter and nine months ended July 31, 2017. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data.
Business context
Keysight provides electronic design, test and measurement products and related services. It completed its acquisition of network-testing company Ixia on April 18, 2017; Ixia’s results are included from that date as the Ixia Solutions Group (ISG). The filing also reports a subsequent acquisition of Scienlab, completed August 31, 2017, for approximately $62 million in cash.
Financial performance
| Metric | Q3 FY2017 | Q3 FY2016 | Nine months FY2017 | Nine months FY2016 |
|---|---|---|---|---|
| Net revenue | $832 | $715 | $2,311 | $2,167 |
| Gross margin | 49.4% | 56.8% | 53.1% | 55.6% |
| Operating income (loss) | $(4) | $106 | $200 | $299 |
| Net income (loss) | $(18) | $91 | $140 | $243 |
| Diluted EPS | $(0.10) | $0.53 | $0.78 | $1.41 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $249 | $277 |
Q3 revenue grew 16% year over year (17% excluding currency effects); nine-month revenue grew 7%. Orders were $879 million in Q3, up 24%, and $2.379 billion for nine months, up 11%. Ixia contributed materially to reported growth; management attributed 12 percentage points of revenue growth to Ixia for both periods in its overview.
Q3 product revenue was $695 million and services and other revenue was $137 million. The Q3 operating loss and lower margin reflected acquisition-related amortization, integration costs, higher selling and administrative spending, and other cost increases. The filing reports $134 million of acquisition-related amortization in the quarter. Nine-month results include a $68 million gain from settlement of a Japanese pension plan; acquisition and integration costs were $38 million in the financial statement note, plus $28 million of acquisition-related compensation expense.
Segments and material changes
- Communications Solutions Group: Revenue was $418 million for Q3, down 1%; nine-month revenue was $1.276 billion, down 3%. Management cited weakness in aerospace, defense and government, partly offset by commercial communications, including demand related to 5G and next-generation data-center technologies.
- Electronic Industrial Solutions Group: Revenue was $218 million for Q3, up 14%; nine-month revenue was $630 million, up 10%, with strength in semiconductor measurement, automotive and energy markets.
- Services Solutions Group: Revenue was $107 million for Q3, up 4%; nine-month revenue was $309 million, up 5%.
- Ixia: Reported net revenue was $89 million in Q3 and $97 million for the nine-month period. Segment reporting separately adds acquisition-related amortization to arrive at segment revenue of $120 million and $132 million, respectively.
Q3 gross margin fell 7 percentage points and operating margin fell 15 percentage points year over year. For the nine months, gross margin declined 2 points and operating margin declined 5 points. R&D spending increased 26% in Q3 and 12% for nine months; selling, general and administrative expense increased 43% and 24%, respectively, largely reflecting Ixia, acquisition-related amortization, integration and personnel costs.
Financial position, cash flow and liquidity
- At July 31, 2017, cash and cash equivalents were $873 million, versus $783 million at October 31, 2016. Approximately $800 million was held outside the United States.
- Total debt was approximately $2.087 billion, including $40 million current and $2.047 billion long term, compared with $1.093 billion at October 31, 2016. Cash less debt was approximately negative $1.214 billion.
- Nine-month operating cash flow was $249 million. Investing cash use was $1.646 billion, primarily reflecting the Ixia acquisition; financing provided $1.482 billion, including debt and a $444 million net public-offering proceeds.
- The company had no borrowings outstanding on its $450 million revolving credit facility at quarter end. It had $300 million outstanding on a three-year term loan and $700 million of 4.60% senior notes due 2027.
- Management said cash, operating cash generation and access to capital markets and credit lines were expected to meet liquidity needs for at least the next 12 months. Expected FY2017 capital expenditures were approximately $85 million.
Outlook, risks and unusual items
- Management estimated a long-term market growth rate of 4%–5%, while noting mixed near-term macroeconomic indicators. The filing does not provide specific next-quarter revenue or earnings guidance.
- Keysight expected $4 million–$7 million of additional separation-related costs through FY2018. A targeted workforce reduction program had resulted in approximately 60 employee exits by July 31, with completion expected substantially by FY2017 year-end.
- The Q3 income-tax benefit was $7 million and included a $33 million net discrete benefit, primarily related to post-acquisition tax restructuring. The estimated annual effective tax rate, excluding discrete items, was 12.2%.
- A Malaysian tax authority assessment of $70 million, including penalties, remained disputed and unreserved. Keysight said it believed it had defenses, including that the relevant statute of limitations had closed and the income was exempt.
- Management identified risks including successful integration of Ixia, acquisition-related costs and debt, volatile customer demand and macroeconomic conditions, competition and product transitions, foreign exchange exposure, supply-chain and inventory commitments, and tax and regulatory matters. The filing reported no pending legal matter it believed probable of having a material impact.
- The preliminary Ixia purchase-price allocation remained subject to refinement during the measurement period; revisions could be material. Ixia added substantial goodwill and intangible assets and related amortization expense.
Investor verification points
- Reconcile Ixia’s reported revenue with segment revenue, which includes acquisition-related amortization, and confirm the acquisition’s ongoing contribution to growth and profitability.
- Track gross-margin recovery, acquisition amortization, integration spending and progress toward any expected Ixia synergies.
- Assess debt repayment, interest expense, cash generation and the use and accessibility of cash held outside the United States.
- Monitor the disputed $70 million Malaysian tax assessment, tax restructuring effects and future tax incentives.
- Review subsequent disclosures on Scienlab’s purchase accounting and integration, and any updates to the preliminary Ixia valuation.