Keysight's (KEYS) Earnings Decline In Q3, Revenues Up Y/Y

Share price of Keysight Technologies Inc. (NYSE:KEYS) has had an unstable run since the company announced its third-quarter fiscal 2017 results on Aug 30. Following the announcement, the stock rallied 1.6% on Aug 31, but declined 0.8% to close at $40.55 on Sep 1.

Keysight reported non-GAAP earnings of 61 cents per share that declined 2.6% from the year-ago quarter. The Zacks Consensus Estimate was pegged at 54 cents.

Non-GAAP revenues surged 21.4% from the year-ago quarter to $863 million. Core revenue (excluding the impact of currency and revenue from acquisitions completed within the last twelve months) increased 4% year over year and was better than management’s guidance of 2% growth.

Geographically, core revenues grew 1% in the Americas, 8% in Europe, 2% in Japan and 6% in Asia excluding Japan.

Orders grew 24% year over year to $879 million. The robust growth reflects strong demand for Keysight’s solutions. The company’s focus on launching new solutions for growth markets like 5G, Internet of Things (IoT), next-generation wireless, high-speed datacenters and automotive & energy are key catalysts.

Keysight has gained 10.9% year to date, outperforming the 9.1% rally of the industry it belongs to.

Segment Details

Communications Solutions Group (CSG) includes commercial communications (CC) and aerospace, defense & government (ADG) end markets. Revenues decreased 1.4% to $418 million and accounted for 49% of total revenue.

CC revenues were almost flat as growth in wireless was partially offset by sluggish infrastructure spending. ADG revenues declined, reflecting softer spending in the United States due to budget approval delays.

Keysight stated that orders for 5G solutions more than doubled on a year-over-year basis in the quarter. The company’s expertise in high-frequency and millimeter wave technologies is helping it to partner innovators like Verizon Communications Inc. (NYSE:VZ) in the domain.

IoT also presents significant growth opportunity based on the company’s broad and diverse portfolio that effectively addresses the needs of customers related to power consumption, RF performance, interoperability and conformance testing.

Electronic Industrial Solutions (Group) revenues increased 14.1% to $218 million. The segment accounted for 25% of total revenue. General electronics, semiconductor measurement solutions and automotive & energy solutions all reported double-digit growth.

Moreover, management noted that growing demand for electric and hybrid cars bodes well for the company’s product portfolio. Further, increasing electronic content in vehicles, radar technologies for autonomous driving and high-power devices and applications are driving demand for the company’s solutions in this end-market.

Services Solutions Group (SSG) revenues were $107 million, up 11.5%. The segment accounted for 12% of total revenue. The year-over-year growth was driven by strength in repair, calibration services and increased sales of remarketed solutions.

The newly constituted Ixia Solutions Group (ISG) delivered revenues of $120 million and accounted for 14% of total revenue. The company achieved strong growth among service provider customers, while the enterprise spending was sluggish in the United States. Moreover, Keysight believes that strong demand for 400G optical technology and higher spending will drive growth going ahead.

Margins

Gross margin expanded 170 basis points (bps) on a year-over-year basis to 61%.

Segment-wise, CSG and SSG gross margin contracted 50 bps and 60 bps, respectively. EISG gross margin expanded 40 bps from the year-ago quarter.

Research & development (R&D), as percentage of revenues, expanded 40 bps to 14.7%. Selling, general and administrative (SG&A), as percentage of revenues, expanded 180 bps to 27.6% in the quarter.

As a result, operating expenses, as percentage of revenues, increased 240 bps to 41.9%.

Non-GAAP operating margin contracted almost 70 bps to 19% in the quarter.

Balance Sheet & Cash Flow

Keysight ended the third quarter with cash & cash equivalents of $873 million. Cash flow from operations was $98 million, while free cash flow was $77 million.

Moreover, the company paid $240 million of debt related to the Ixia acquisition.

Guidance

Keysight projects non-GAAP revenues to be in the range of $875-$905 million, representing 3% core growth at the midpoint for the fourth quarter of fiscal 2017.

Management stated that ADG orders have stabilized and spending is expected to improve in the fourth quarter. However, the company stated that it is “difficult to predict exactly when the flow of funding will return to a steady state in this end-market.”

Keysight expects semiconductor measurement solutions growth to be moderate in the fourth quarter of fiscal 2017 and first quarter of fiscal 2018.

Related to the ISG segment, management expects to achieve annualized run-rate cost synergies of $40 million by third quarter of fiscal 2018. The company remains committed to deliver the full $60 million cost synergies over time.

Non-GAAP earnings are expected to be in the range of 59-69 cents per share or 64 cents at the mid-point.

For fiscal 2018, Keysight expects non-GAAP earnings to be at the high end of the previously provided range of 8-10% annual growth.

Zacks Rank & Key Picks

Currently, Keysight has a Zacks Rank #3 (Hold). Fitbit Inc. (NYSE:FIT) and Orbotech Ltd. (NASDAQ:ORBK) , both carrying a Zacks Rank #2 (Buy), are two stocks worth considering in the same sector. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Long-term earnings growth rate for Fitbit and Orbotech are pegged at 22.5% and 18.8%, respectively.

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