Keysight Technologies, Inc. — Q2 FY2020 Form 10-Q
Reporting period: Fiscal quarter and six months ended April 30, 2020. Unaudited results; dollar amounts are in millions unless noted. Keysight provides electronic design and test solutions and related services. Its two reportable segments are Communications Solutions Group (CSG) and Electronic Industrial Solutions Group (EISG).
Financial results and position
| Metric | Q2 FY2020 | Q2 FY2019 | Six months FY2020 | Six months FY2019 |
|---|---|---|---|---|
| Revenue | $895 | $1,090 | $1,990 | $2,096 |
| Gross margin | 57.7% | 59.5% | 58.9% | 58.5% |
| Operating income | $102 | $185 | $305 | $306 |
| Operating margin | 11.4% | 17.0% | 15.3% | 14.6% |
| Net income | $71 | $153 | $234 | $267 |
| Diluted EPS | $0.37 | $0.80 | $1.23 | $1.40 |
- Q2 product revenue fell 22% to $708; services and other revenue increased 5% to $187. Six-month revenue declined 5% year over year.
- Q2 orders were $1,089, down 3% year over year; six-month orders were $2,230, up 4%.
- For the six months, operating cash flow was $495, capital expenditures were $55, and free cash flow calculated as operating cash flow less capital expenditures was $440. Cash provided by operating activities was $461 in the comparable period.
- Cash, cash equivalents and restricted cash totaled $1,843 at April 30, 2020, versus $1,600 at October 31, 2019. Current assets were $3,293 and current liabilities $949.
- Long-term debt was $1,788, unchanged from October 31, 2019. The $450 revolving credit facility had no borrowings; Keysight reported covenant compliance.
- Q2 CSG revenue was $653 and EISG revenue was $242. Segment operating income was $114 and $59, respectively; these segment measures exclude specified items and are not GAAP operating income.
Material changes and unusual items
- Q2 revenue fell 18% and net income fell $82 year over year, primarily due to lower volume amid COVID-19-related site closures and supply-chain disruption in the latter half of the quarter. Q2 operating margin contracted 5.6 percentage points, as reported in the filing as a 6-point decline.
- Management said favorable mix and lower variable people-related and discretionary costs partly offset the revenue pressure. Six-month operating income was nearly flat year over year; the comparison included a $32 gain from wildfire-related insurance proceeds in FY2020.
- Keysight received $37 of insurance proceeds in the first quarter related to 2017 Northern California wildfire damage. No further material proceeds or expenses were expected.
- The six-month effective tax rate was 24.6%, versus 14.8% a year earlier; the prior-year period included a $29 discrete tax benefit. Q2 FY2020 effective tax rate was 34.9%.
- Keysight adopted the new lease standard on November 1, 2019, recording operating-lease right-of-use assets and obligations. Management reported no material effect on earnings or cash flows from adoption.
Outlook, risks and contingencies
- Management expected continued COVID-19 demand and supply-chain headwinds over the next few quarters, while citing ongoing customer investment in 5G, 400G, advanced semiconductor processes and other next-generation technologies. No numerical revenue or earnings guidance is provided in the supplied filing text.
- In response to uncertainty, the company temporarily froze hiring and reduced discretionary spending, variable compensation and outsourced manufacturing costs. It was reopening sites and ramping production and services while observing local requirements and safety procedures.
- Management said available cash, operating cash generation and access to capital markets and credit lines were expected to meet liquidity needs for at least 12 months. Fiscal 2020 capital spending was expected to be approximately $105.
- Key stated risks include further pandemic-related shutdowns, supply constraints, weaker customer spending or payment capacity, trade and export restrictions (including China), foreign-exchange exposure, and the risk that investment in new technologies does not deliver expected returns.
- Keysight reported no pending legal matters it believed reasonably possible or probable to have a material impact. A Malaysian tax dispute remains under appeal: the company had paid $68 in tax and penalties in 2017 and appealed the assessment to the High Court.
- The company entered forward-starting interest-rate swaps with $600 aggregate notional during Q2, linked to anticipated debt issuance through FY2024. It reported no material goodwill impairment trigger as of April 30, 2020.
Important facts for investors to verify
- Whether revenue, orders and margins recover as production and customer operations resume, and how long COVID-19-related disruption persists.
- Whether the decline in Q2 results reflects temporary volume and mix effects or more sustained weakness, particularly in automotive, general electronics and aerospace, defense and government markets.
- The degree to which six-month operating results and cash flow depend on the one-time $32 wildfire insurance gain and favorable working-capital movements.
- Future cash needs and capital allocation, including remaining authorization under the $500 repurchase program; approximately $215 remained at April 30, 2020.
- Developments in the Malaysian tax appeal, renewal of foreign tax incentives, and any resulting change to tax expense or cash obligations.