Keysight reported F4Q earnings tonight. In part, results were terrible, such as revenue x-acquisitions, net debt, share count, and FCF. In part, results are confusing in the sense that weak guidance comes as a result of recent forest fires in California...and while this fits a long string of annual revenue excuses for Keysight, we aren't Short Keysight because of one-time regrettable disruptions to California operations. We moved to the Bench ahead of the current EPS season hoping to get past what we saw as positive layers of M&A guidance. We intend to come back to it as the setup dictates.
Details
Keysight reported $902m revenue relative to Street expectations of $887m, and non-GAAP EPS was $0.71 versus Street at $0.65.
FCF was a complete stink bomb at $46m versus the Street at $118m and leaves the stock trading at 37x trailing FCF and 36x post deal run-rate FCF. Yikes.
That’s what happens when revenue is acquired. No incremental FCF. That’s also what happens when you acquire a company (Ixia) that was massively overstating FCF.
In this case one of the big factors was Pension cost in F4Q of around ~$70m which explains most of the delta. It is nice to be able to admit that we had done that work (found in our BlackBook – LINK) and analyzed the real cash headwinds to Keysight from the pension side. Remember everyone: this aint no SaaS 2.0 stock. This is one of the great great grandaddys in tech. Pension expense is real.
Other important negatives that stood out in the reported quarter:
- Net debt up q/q. So much for de-levering, becoming a FCF king, and giving it all to shareholders
- Ixia revenue flat y/y if comp’d to 3Q16 (sep30)…hey what happened to all that promised growth?
- Diluted share count is up again sequentially, now up 10% y/y thanks to Ixia (disaster). Why does it continue to rise sequentially? The BoD’s gotta eat!
- Non-GAAP revenue of $902m…includes two out of three months of what might be ~$10-15m of ScienLab revenue (if book to bill is close to 1x for ScienLab, you can back into this # by looking at the sequential growth of non-core orders of ~$17m that comes from Ixia and ScienLab)
- Did 5G decelerate? KEYS said 5G revenue up d-d% y/y for the year, but in each prior quarter they said it was up triple digit y/y on a quarterly basis. Last year 5G orders were $66m…
- EISG revenue was down 6% q/q despite adding in 2 months of ScienLab revenue
The big issue everyone has is on guidance. Keysight guided 1Q non-GAAP revenue of $800m at the midpoint, approximately -7.5% below the Street. The company blamed the recent fires in Santa Rosa California which forced them to shut down an operations site for a few weeks. To reassure investors management guided 1H revenue ~1% above Street, implying that lost 1Q revenue would shift to 2Q. I am not offended by such a suggestion but the Street will worry first and figure it out later, given this is short-turns business. The company reported $902m of revenue in the quarter, for example, but finished the year with $392m of deferred revenue on its books. There is no guarantee that lost revenue will return.
Net – this remains a walking dead company, an ancient whose revenue declines (for one excuse or another) across any multi-year time frame on a core organic basis, and whose board has made some poor acquisitions to try to offset the declines. To top it all off, the stock trades in the stratosphere at 36x run-rate FCF. Ouch.
The bulls will eat up the 5G acceleration and look past the pit of F1Q guidance. We think – notwithstanding the one-time shift of revenue – that topline problems mount by F2Q-F4Q as M&A growth rate ends. We think the holes the bulls have to contend with today are from balance sheet and FCF.
