Keysight Technologies, Inc. — Q1 FY2017 Form 10-Q
Business context and reporting period
Keysight provides electronic design and test instruments, systems, software and related services to communications and electronics industries. This unaudited report covers the three months ended January 31, 2017, compared with the three months ended January 31, 2016. Fiscal Q1 ended January 31.
Financial results and liquidity
| Metric | Q1 FY2017 | Q1 FY2016 |
|---|---|---|
| Orders | $695 million | $679 million |
| Revenue | $726 million | $721 million |
| Gross margin | 55.7% | 54.3% |
| Operating income | $162 million | $98 million |
| Operating margin | 22.4% | 13.6% |
| Net income | $109 million | $64 million |
| Diluted EPS | $0.63 | $0.37 |
| Operating cash flow | $102 million | $92 million |
Revenue grew 1% and orders grew 2% year over year. Products revenue was $606 million; services and other revenue was $120 million. Cash and cash equivalents were $896 million at January 31, versus $783 million at October 31, 2016; approximately $667 million was held by foreign subsidiaries. Current assets were $1.932 billion and current liabilities were $596 million.
Long-term debt was $1.093 billion, comprising $497 million of 3.30% senior notes due 2019 and $596 million of 4.55% senior notes due 2024. There were no borrowings outstanding under the revolving credit facility at January 31. Investing activities used $8 million, including $16 million of property and equipment investment and $8 million of land-sale proceeds. Financing activities provided $21 million. The company expected approximately $100 million of capital expenditures for FY2017.
Material changes versus the prior comparable period
- Net income rose $45 million, but operating income included a $68 million gain from a Japanese pension settlement and an $8 million gain on land sales. The reported operating-margin increase therefore substantially reflects unusual gains, rather than solely underlying operating performance.
- Gross margin increased 1.4 percentage points, attributed mainly to lower warranty and inventory charges, partly offset by higher people-related costs. SG&A rose 7% to $213 million, primarily due to people-related and acquisition/integration costs; R&D was $108 million in both periods.
- Revenue by segment: Communications Solutions Group (CSG) $434 million, down 1%; Electronic Industrial Solutions Group (EISG) $192 million, essentially flat; Services Solutions Group (SSG) $100 million, up 5%. CSG weakness reflected a 6% decline in aerospace, defense and government, partly offset by 2% growth in commercial communications. EISG semiconductor-measurement growth offset declines elsewhere.
- Effective tax rate was 28.3%, versus 23.7%. The current-quarter provision included $23 million of net discrete expense, primarily $22 million of tax associated with the pension-fund transfer.
- Cash increased $113 million during the quarter. Operating cash flow improved to $102 million; the period also included significant pension-related and working-capital cash movements.
Outlook, management commentary, risks and unusual items
Management estimated long-term market growth of 2%–3%, while describing near-term macroeconomic indicators as mixed. It highlighted strength in 5G and next-generation data-center technologies, offset by weakness in aerospace, defense and government, and said it remained focused on innovation and operational efficiency. The company expected to contribute approximately $25 million to non-U.S. defined-benefit plans during the remainder of FY2017.
Keysight agreed to acquire Ixia for approximately $1.6 billion, net of cash acquired, in an all-cash transaction at $19.65 per share. Closing was anticipated by the end of October 2017, subject to Ixia shareholder approval, regulatory approvals and other conditions. Financing arrangements included a bridge facility of up to $1.684 billion, a $400 million delayed-draw term loan and a $450 million revolving facility. The filing warns that financing, regulatory, integration and other conditions could delay or prevent completion. A putative shareholder lawsuit filed in February 2017 seeks to enjoin or rescind the transaction. Under specified circumstances, failure to close could require a $500 million reverse termination fee.
A targeted workforce reduction begun in November 2016 was expected to affect 60–200 employees; approximately 20 had exited by January 31, with $2 million of expense recognized. The company expected substantial completion by the end of Q2 FY2018. It also expected $19–$29 million of additional separation-related costs through FY2018. The filing identifies broad risks including cyclicality and uncertain demand, technology and product competition, supply-chain and outsourcing dependencies, foreign-currency exposure, tax examinations and incentives, pension funding, cybersecurity, litigation and acquisition execution. Management stated that it believed available cash, operating cash generation and access to capital markets and credit lines would meet liquidity needs for at least the next 12 months.
Important facts for investors to verify
- How much of reported operating-income growth is attributable to the $68 million pension-settlement gain and $8 million land-sale gain, and how underlying margins trend excluding unusual items.
- Whether order trends, segment performance and demand conditions—particularly in aerospace, defense and government—support management’s market-growth outlook.
- Whether the Ixia acquisition receives required approvals, closes on expected terms and timing, and can be financed without materially increasing debt costs or liquidity risk.
- The outcome and potential cost of the Ixia-related lawsuit, including any effect on closing conditions or the potential termination fee.
- The impact of the discrete tax expense, future tax examinations and renewal requirements for tax incentives on the company’s effective tax rate.