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Bear of the Day: Keysight Technologies (KEYS)

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Keysight Technologies (KEYS - Free Report) is a $19 billion provider of electronic design, measurement and test instrumentation systems. Keysight emerged as a public company from the 2014 move by Agilent Technologies to split apart divisions. 
KEYS provides specialized electronics solutions to dozens of industries including aerospace and defense, automotive and energy, telecommunications, government and education, and, of course, semiconductors.
And even though the company finds itself classified in the Zacks Electronics - Measuring Instruments industry, it is as much a software company. More on that coming up when I tell you about their recent key acquisition that rolls in AI-powered software test automation.
Keysight calls the top 25 technology enterprises in the world customers, and 78 of the Fortune 100, including Alphabet (GOOGL - Free Report) , Amazon (AMZN - Free Report) , AT&T, Broadcom, Boeing, Cisco, Microsoft (MSFT - Free Report) , NVIDIA (NVDA - Free Report) , Samsung, Tesla (TSLA - Free Report) and Toyota.
But KEYS is back in the cellar of the Zacks Rank since the global shutdown disrupted manufacturing and supply chains. And analysts took estimates down further since the company reported a weaker-than-expected quarter on May 26.
Keysight Q2 Earnings Miss Estimates, Revenues Down Y/Y
Keysight Technologies, Inc. delivered second-quarter fiscal 2020 non-GAAP earnings of 78 cents per share, missing the Zacks Consensus Estimate by 22%. The bottom line also declined 36.1% from the year-ago quarter.
Non-GAAP revenues declined 18% year over year to $895 million. Non-GAAP core revenues (excluding the impact of currency and revenues from acquisitions in a year’s time) fell 18% on a year-over-year basis to $892 million. Moreover, GAAP revenues slumped 18% from the prior-year quarter to $895 million. The Zacks Consensus Estimate for revenues was pegged at $1.02 billion.
The coronavirus crisis-induced supply chain disruption and shutdown of production facilities affected Keysight’s fiscal second-quarter results.
Quarter in Detail
Orders fell 3% on a year-over-year basis to $1.089 billion during the reported quarter. Notably, core orders declined 3%.
Beginning first-quarter fiscal 2020, the company’s financial reporting comprises two segments — Electronic Industrial Solutions Group (EISG) and Communications Solutions Group (CSG). Ixia Solutions Group (ISG) segment reporting has been aligned with the CGS segment.
CSG includes commercial communications (CC) and aerospace, defense & government (ADG) end markets. CSG revenues of $653 million declined 18% on year-over-year and core basis. CSG contributed 73% to total non-GAAP revenues in the fiscal second quarter. CC revenues of $468 million were down 15% year over year due to coronavirus crisis-induced supply chain disruption. However, management noted robust 5G order growth primarily fueled by 5G investments.
ADG revenues came in at $185 million, down 25% year over year, due to lower international spending. However, higher government spending and momentum in investments aimed at technology modernization, across the United States, was a positive.
EISG revenues declined 19% to $242 million. Challenges pertaining to automotive sector weighed on revenues. However, management noted momentum in first-to-market solutions, and demand for the company’s solutions in process node technology testing, considering semiconductor vertical. EISG contributed 27% to total non-GAAP revenues in second-quarter fiscal 2020.
Non-GAAP revenues from Americas came in at $330 million, down 23% year over year. Non-GAAP revenues from Europe and Asia Pacific of $145 million and $420 million declined 19% and 14%, respectively, on a year-over-year basis. Americas, Europe and Asia Pacific contributed 36.9%, 16.2% and 46.9%, respectively, to total non-GAAP revenues in the reported quarter.
Margin Highlights
Non-GAAP gross margin contracted 90 basis points (bps) to 62.8% during the reported quarter. CSG gross margin of 63.1% contracted 150 bps, while EISG’s gross margin of 61.1% expanded 70 bps on a year-over-year basis.
Non-GAAP operating expenses fell 9.1% to $389 million. As a percentage of revenues, the figure expanded 430 bps to 43.5%.
Consequently, non-GAAP operating margin contracted 520 bps to 19.4%.
The company is improving production and services operations and anticipates returning to 100% capacity by the end of the fiscal third quarter amid persistent supply chain challenges.
Analyst Estimate and Price Target Moves
In the past 60 days, the window for the Zacks Rank, consensus EPS for FY20 (ends in October) has dropped 15.5% from $4.96 to $4.19, representing an 11% annual profit decline from last year.
And revenues are projecting to come in 6.25% lighter near $4 billion.
After the late May report, Citi analyst Jim Suva said management's commentary on its earnings call shows its fundamentals are already improving with a book to bill of 1.22 times and the company commenting that the July quarter will see sales and margins "flat to up." The stock will be under pressure near term as consensus estimates recalibrate lower, but the stock pressure will be short lived as production is ramping. The analyst kept a Buy rating on the shares.
JPMorgan analyst Samik Chatterjee upgraded Keysight Technologies to Overweight from Neutral with a price target of $127, up from $112. The analyst recommends the shares to investors looking for recovery plays within the networking equipment space. The sector has been "largely unscathed" by the COVID-19 disruption, and Keysight offers the opportunity to participate in "robust growth" for test and measurement equipment in the communications end-market with "strong leverage" to the 5G cycle. The company is cycling past supply headwinds, which sets up the shares as a recovery play, said Chatterjee.
Eggplant and Testing Software: A Delicious AI Combination
Finally, on Thursday Keysight Technologies announced the company had completed the acquisition of Eggplant from The Carlyle Group. Eggplant is a software test automation platform provider that uses artificial intelligence and analytics to automate test creation and test execution. Eggplant's Digital Automation Intelligence platform can test any technology on any device, operating system or browser at any layer, from the user interface to application programming interfaces to the database.
This transaction is valued at US $330 million. London-based Eggplant had 2019 revenue of US $38 million and its CEO, John Bates, will join the Keysight leadership team reporting to Soon Chai Gooi, president of Keysight's Electronic Industrial Solutions Group.
This relatively inexpensive acquisition sounds like powerful synergistic scoop by Keysight. It will keep them being an innovative player on the frontiers of technology testing systems. 
Plus, Keysight appears to have a strong suite of design, testing, monitoring, and validation software that is allowing companies to keep working remotely. From their website...
"Whether working on design and simulation, or managing multiple instruments and test stations remotely, our PC-based software can help you stay productive at home, at the office, or anywhere you need to innovate." 
I would look to be a buyer of KEYS when the estimates stop going down and start heading back up. The Zacks Rank will let you know.
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