Operator:

Good day, ladies and gentlemen, and welcome to Keysight Technologies Fiscal Second Quarter 2024 Earnings Conference Call. My name is Sierra, and I will be your lead operator today. [Operator Instructions]. This call is being recorded today, Monday, May 20, 2024, at 1:30 p.m. Pacific Time.

Jason Kary:

Thank you, and welcome, everyone, to Keysight's Second Quarter Earnings Conference Call for Fiscal year 2024. Joining me are Keysight's President and CEO, Satish Dhanasekaran; and our CFO, Neil Dougherty. In the Q&A session, we'll be joined by Chief Customer Officer, Mark Wallace. The press release and information to supplement today's discussion are on our website at investor.keysight.com under Financial Information and Quarterly Reports.

Neil Dougherty:

Thank you, Satish, and hello, everyone. Second quarter revenue of $1.216 billion was just above the high end of our guidance range and down 13% or 14% on a core basis. Orders of $1.219 billion declined 8% or 9% on a core basis. As a reminder, Keysight's historical first to second quarter seasonality was muted by the cadence of the ESI business with approximately half of ESI orders and revenue recognized in the first quarter of the fiscal year. Excluding ESI, orders grew 4% sequentially, and revenue was in line with Q1. We ended the quarter with $2.3 billion in backlog.

Jason Kary:

Thank you, Neil. Sierra, would you give the instructions for the Q&A, please?

Robert Mason:

So I'm thinking -- it sounds like your base case for the year, obviously, is still intact. Just thinking through that more thoroughly, the orders typically in the third quarter maybe down -- maybe flat to down slightly sequentially. And then you have better order trends in the fourth quarter seasonally. Should we think this is, again, still tied more to book and ship as you think about the revenue upticking in the fourth quarter? Or any help you can provide just on the clarity for that slope?

Robert Mason:

Very good. And then just as a follow-up, could you dig a little bit deeper into your overall Wireline business, the AI data center piece, obviously, seeing some strength. I'm just curious with these new platforms that are rolling out, what stage of adoption are we seeing with those? And just comment more broadly on the Wireline business over and beyond the AI data center exposure?

William G. Bryant:

This is Will Bryant on for Mark Delaney. So in your press release, you all reiterated that you are assuming modest order growth in the second half of the fiscal year. Can you give us some additional color on what gives you confidence that the orders will pick up in the second half?

William G. Bryant:

That's helpful. And just 1 quick follow-up on just thinking about how you guys are managing OpEx as you guys are planning the business in these volatile end markets. Could you give us any additional color about what you want to manage OpEx?

Operator:

Our next question today comes from Aaron Rakers with Wells Fargo.

Neil Dougherty:

Yes. So I'll take the first question, sizing of [semi and then] hand it over to Mark to make some comments on the market. What we've said is that our semi business is kind of 10-ish percent of total Keysight maybe a little less.

Operator:

Our next question today comes from Meta Marshall with Morgan Stanley.

Satish Dhanasekaran:

Thank you, Meta. Again, we're quite pleased with the acquisition. The performance in the first half has exceeded our initial plans, so which is good. Again, I view this simulation and emulation as a long-term strategic priority for the company and ESI was clearly -- gave us some differentiated capability to go pursue it. The culture fit 1, 2 quarters in is re-traded because our teams are working seamlessly, the collaborative culture, the focus on technology, all of those things are headed in the right direction. .

Mark Wallace:

Thanks, Satish. It's been an exciting quarter and half for us as we've begun to work more closely across different geographies, really the plan that we put in place back in late Q1 continues to be the plan we're executing around our common areas of focus from a customer standpoint in North America, where ESI is underexposed with aerospace defense. And then in both directions around auto, especially in Europe, we're seeing opportunities open for both our classic business and working closely with ESI.

Neil Dougherty:

And just a quick comment on long-dated orders. The mix of long-dated disorders within the quarter were consistent with the recent past.

Matthew Niknam:

Just 2, if I could. First, maybe big picture if you could talk a little bit about the Spirent deal, why now and maybe some of the strategic rationale behind that deal? And then secondarily, just as we think about operating cash flow, maybe for Neil, if you could just maybe talk a little bit about some of the drivers of relative softness this quarter and how to think about working cap and some of the other items that go into that for the second half of the year?

David Ridley-Lane:

Several competitors have pushed out their own recovery time lines. You're obviously sticking with yours. What are the 1 or 2 things that you would point to in the results that give you the most confidence in that outlook?

Neil Dougherty:

No expanded actions. I think if you're looking at the reconciliations that were provided -- the category is actually listed as restricting other and there was a modest legal settlement that occurred within the quarter as well that's skewing that number higher.

Adam Thalhimer:

In the EISG segment in the ESG segment, do you see revenue -- do you see further weakness in revenue and margins in the back half? Or do you think things improve versus Q2?

Neil Dougherty:

Yes. As you think about the margin situation in EISG, I highlighted kind of 3 factors, right, the seasonality of ESI, which is strongly profitable in Q1 in a modest loss position in the remainder of the year, that is impacting ISG profit. But by far the biggest -- the biggest driver is the revenue decline, right? So revenues down sharply here in Q2. And I think as long as we're operating in these revenue ranges, it's going to be reasonably range-bound in the current operating margin vicinity.

Adam Thalhimer:

Okay. And then 1 for commercial communications on -- can you help us frame the AI data center opportunity for you guys versus 5G at the peak?

Mehdi Hosseini:

Two follow-ups. Satish, I'm trying to better understand how you're managing business beyond the second half -- and I want to go back to the Analyst Day, you talked about the 5% to 7% longer-term revenue growth. And obviously, 2023 -- fiscal year '23, turned out will be a lot worse. So it helps you with a lower base. And if I even think of the low end of that longer-term revenue target range, your revenues in FY '25 and '26 would need to be up double digit. And what I want to understand, as I noted earlier, I want to see how you're planning how you're running the operation. I don't see any 1 killer app on the horizon. There are several smaller killer app. And to what extent M&A is going to be part of your strategy to hit that revenue target? And I have a follow-up.

Neil Dougherty:

Yes. I think over time, Mehdi, but I think in the short run, the way we think about free cash flow internally is we look for a relatively high conversion of non-GAAP net income into free cash flow. And we've talked about running that in the 90% or higher range. And so while we don't have a specific free cash flow guide that we put out there, I think that's how we think about it over the longer term. The 1 thing that I would say, and you can see this by looking back in our history, is that there are periods of time where we have kind of nonstandard cash flow items that can reduce that level of free cash flow conversion. And specifically, I'm thinking about things like restructuring costs. And most notably, given where we are right now, M&A costs, either integration or transaction costs associated with M&A.

Operator:

Thank you all for your questions. That will conclude our Q&A session for today. I would like to turn the call back to Jason Kary for any closing comments.

Operator:

Thank you. That will conclude today's conference call. Thank you all for your participation. You may now disconnect your lines.

Operator:

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal First Quarter 2024 Earnings Conference Call. My name is Joel, and I'll be your lead operator today. [Operator Instructions] This call is being recorded today, Tuesday, February 20, 2024 at 1:30 PM Pacific Time. I would now like to hand the call over to Jason Kary, Vice President, Treasurer and Investor Relations. Please go ahead, Mr. Kary.

Satish Dhanasekaran:

Good afternoon, everyone, and thank you for joining us today. My comments will focus on three key headlines

Jason Kary:

Thanks, Neil. Joel, could you please give the instructions for the Q&A?

Samik Chatterjee:

Hi. Thanks for taking my questions. Maybe if I can start with the first one, just on the sort of what you're implying in terms of the recovery for the back half. I mean, just looking at the 2Q guide, to me, it implies that the organically the business is -- or the core business is down a bit and there is some ESI revenue sequentially declining as well. But if the core business is down sequentially, what's driving the expectation for a recovery starting in 3Q and 4Q? I know you said you're not baking in a recovery in relation to the macros, so is there something more customer-specific or end-market-specific that you're seeing that's driving that expectation? Then, I have a quick follow-up. Thank you.

Samik Chatterjee:

Okay. I guess -- sorry, Satish, just to clarify, I was more looking at what's the driver there? I mean, when you call it seasonal, it's been below seasonal for a bit. So, is it something more specific to the end markets? And I'll ask my follow-up at same time, if you don't mind.

Samik Chatterjee:

If you can just shed a bit more light on the order trends in relation to EISG? I know you said, largely unchanged spending, but what are you seeing in the different verticals when it comes to autos versus broader industrial because we've seen a lot of weaker macro data points on that front? Thank you.

Operator:

Thank you. The next question is from Mark Delaney with Goldman Sachs. Your line is open.

Satish Dhanasekaran:

Yeah, that's a really good question. It's still an emerging opportunity for us, but what is significant this quarter is, we started to see the wireline core parts of our business inflect. And if you recall in the past earnings calls, I've talked about the traffic patterns caused by generative AI really impacting the whole network architecture, compute to networking and switching and silicon, and therefore, we knew that demand was coming up. And so, what we noticed this quarter is our wireline business started to inflect, driven by 400-gig and 800-gig transceiver business in manufacturing as that starts to scale, increased focus on terabit research, we announced a collaboration with Marvell in advanced technologies as well there. So that's the business of today. But as we start to think about the broader landscape here, I would say the memory technologies with HBM is starting to gain interest in our customers, different processor architectures, increased silicon activity enabled by AI. And then, for us, it's very exciting because there is a lot of tools that we can deploy our IP because we have the total stack to help engineers train the AI ML models better. And so, you will see, we announced a collaboration with NVIDIA on this front as well. And there's new interface standards. And you know our business is driven by standardization process. So, new interface standards are good for our CXL PCIe Gen-7 and the Ultra Ethernet Consortium are playing into it. Silicon photonics in quantum, while they are sort of enabling technologies, are other areas where we've had investment, where we're now able to address new opportunities. Now a lot of that is not yet baked into our forecast, but we're continuing to action these things through the investments we're making.

Satish Dhanasekaran:

Thank you. It might be a little too premature to talk about the outer years, but here's how we're thinking about it. We've had -- obviously, this is the second year we're entering in where orders are declining. And every time that's happened, we would expect a bounce back in the outer years to be stronger. So that's still to be proven out. And you know the sort of earnings leverage that we get when we are able to grow our business above our models. So, profitability, I'm pretty encouraged by the strong gross margins we're maintaining even on declining top-line right now, that's a function of the software and services content, and just the discipline which we run our business. And so, I feel like getting our business back to growth is the principal driver. And given all the trends that we see across wireless, wireline, the long-term trends we see in next-gen silicon and aerospace, defense and in semi, we believe that we can get back to this growth model that we put out at Investor Day.

Meta Marshall:

Great. Thanks. And apologies for the background noise. Maybe just a couple of questions for me. Maybe first, and just in terms of -- clearly, you guys were a little bit more cautious entering into the year. You had guided at the full year. I guess I'm just trying to get a sense of versus the environment as you saw 90 days ago, how have your expectations changed? And maybe just on the second question, just in terms of ESI and the earlier closure that we had, just any changes that you can make or able to make to that business kind of earlier than you expected? Thanks.

Mark Wallace:

Yeah. Thanks, Satish. Well, Meta, the pipeline that we see today really supports our base scenario that second-half orders and revenue will be modestly higher than the first half, and this is seen through some improvement in our six-month funnel that Neil mentioned in his prepared statements and we've called out in various other earnings calls as well. The improvement comes in the form of some funnel intake up modestly indicating that we have some green shoots and pockets of demand that are showing up. And the other area is in the funnel velocity, or in other words, how long it takes for opportunities to move through the funnel as some customers are beginning to move a bit more quickly. So, 90 days later, those are the big changes. The short-term funnel is about the same at the beginning of Q1, which still remains constrained, but we are seeing some positive pipeline dynamics as we look out six months.

Satish Dhanasekaran:

Thank you.

Chris Snyder:

Thank you. I guess it sounds like from much of the demand end-market commentary that things are very similar in a demand sense from where they were three months ago. But I guess my question is, is there any place in the business where you see demand continuing to deteriorate on the leading edge? Because orders were down, it seems like on an organic basis, about mid-teens versus Q4, which is a bit sharper than seasonality, and the book-to-bill did step back below 1 after being above 1 last quarter. So, are there any places in the business where things are getting worse? Thank you.

Mark Wallace:

Yeah. I would just add to that, we have said that the weakness is in China for EISG businesses. As we said, if you look at China, we saw customer engagements continue. I was there in December. Our historic exposure to China has been high-teens of revenue. It was a little lower than that in Q1, and it was because of the continued headwinds incrementally worse in semi and manufacturing. But we did see sequential order growth from Q1 to Q -- from Q4 to Q1 driven by this demand that we talked about earlier with growth in 400 gig and 800 gig, R&D for the data center upgrades, some demand for 5G private networks. And as a global company, we're also exposed to some of the offshoring, that has been going on and continues as some of the multinational companies move offshore. And the last thing I'll say is, thinking back over the last several quarters, we vastly de-risked China from a trade perspective. It was it was meaningless in Q1, additions to the RPL have had a [variable] (ph) impact. We continue to monitor the situation very closely. So that's where we've seen some of the headwinds, but even there I've seen some positive indicators in China as well.

Neil Dougherty:

Yeah. So, you're correct. The number is $2.3 billion. And I would start by saying that we now stated a couple of quarters ago that we believe we've worked through the excess backlog. And so -- and we did that last year when revenue outpaced orders by the tune of $275 million or something like that was when we worked through that excess backlog. I think as we look currently, we're managing a couple of things. Obviously, by design, our recurring revenue businesses, software and services are holding up. You see that in an increasing deferred revenue balance. But in addition to this, we're also managing this dynamic between where our -- we've seen a pretty significant increase in these longer-dated orders, which if you remember correctly, historically been about 2% of our incoming order rate and we really didn't talk about it as a result of that. Last year, they were more like 8% of the incoming order rate. They were 8% again here in Q1. And as Mark talked about, we have a robust funnel of longer-dated opportunities as we look out over the course of the next six months. And so, that's the dynamic that we're starting to see. We are starting to see those longer-dated orders show up in revenue. We saw that beginning in Q1. And by Q4, we expect revenue from those longer-dated programs to be about 8% of that Q4 revenue.

Adam Thalhimer:

Hey, good afternoon, guys.

Adam Thalhimer:

I think to get to the -- a question on operating margins. I think to get to the midpoint of guidance, they're down 600 basis points, 700 basis points year-over-year. And my question is, is that what you would expect in your model? Or is there something specifically impacting margins in Q2?

Adam Thalhimer:

Okay. And then just a quick one on -- how is auto demand holding up in this environment, EV/AV charging?

Satish Dhanasekaran:

And also, some of the capabilities that we have developed around electrification are finding new applications in aerospace and defense and other end-markets that are also going to be impacted by the similar trends. And so, we're quite pleased by the leverage and synergies we'll see as we move forward.

Tim Long:

Thank you. I wanted to ask one on the wireless business. Can you just kind of run through some of the technologies and give us a sense how they might be influencing the business? Just curious, you mentioned the 5GPP standards. What's on the come there? Anything new with millimeter wave, or 6G, or O-RAN? If you could just kind of give us a little state of the union on those? And then, I have a follow-up.

Tim Long:

Okay, great. And then I just wanted to follow up on the optical side. It sounds like 400 gig, 800 gig are pretty strong. Could you talk a little bit about what you're seeing on R&D for the cycle beyond that? And also, curious about what's going on the software side Ixia and some of the other software businesses related to optical wireline. Thank you.

Operator:

Thank you. The next question is from the line of Aaron Rakers with Wells Fargo. Your line is open.

Neil Dougherty:

Yeah. From a backlog perspective, we're in the $400 million to $500 million range of our backlog as these long-dated deals. You are correct that they tend to be larger lumpier deals in aerospace, defense, auto, and even in the semi space. And as I said on the previous question about this, we've actually started to see them now, because we started to see the ramp in a little bit in Q1 of last year, but then really in earnest in Q2 of last year on the order line, and some of those things are starting to flow through to revenue now. Now, we're not at 8% yet from a revenue perspective. We expect to be there by the end of the year. But just as you suggested, it is lumpy, right? So, you could end up in a situation where there is relatively lower either order or revenue activity from these types of transactions and some other quarter you might have double activity just given the nature of the business.

Satish Dhanasekaran:

Yeah. I think for us, we don't try to pick winners. In some ways, innovation is best served when you have multiple competing technologies approach the same challenge. But fundamentally, data is growing. The pattern of data through these networks are altering and changing, which requires the communication systems to adapt. And I think all the way from memory to network, NIC cards, to compute architectures are getting more heterogeneous if you will. So, more standards. I talked about CXL, the Ultra Ethernet Consortium, PCIe Gen-7, et cetera. So, all of that really creates a real good bed of technologies for us to service through our platforms. And often, it's the same underlying platform -- I missed out USB 4.0, but often it's the same sort of underlying platforms that we have from all the way from oscilloscopes, to our BERTs, to our network traffic emulators from our Ixia acquisition. So, we tend to go approach these things and then add in more software capabilities as we move forward. We're actually quite pleased with the performance and the resilience of our software business even through these times. And software and services represents roughly now 40% of the total order/revenue in the most recent quarter, and we'll continue to keep growing the value of the company. Our ARR was also up double digits this quarter.

Matt Niknam:

Hey, guys, thanks for taking the questions. Just maybe unpacking the guide for fiscal 2Q, are you anticipating modest sequential pressure across the board? Or are there any pockets in the business where you may be anticipating or seeing some level of sequential improvements in the fiscal second quarter? And then maybe just secondly, in terms of -- we talked a lot about wireline. I'm just wondering on the wireless side, expectations for that business this year, simply given maybe some green shoots we're reading about, and also the fact that seem to be a business that maybe started seeing the downturn a little bit sooner. So, I'm just wondering if there's any additional color you can share in terms of expectations for the year. Thanks.

Mark Wallace:

Yeah. And Matt, I think it's more of the same what we've been speaking about in terms of the markets that are driving growth. I expect aerospace, defense to continue to be an area of driving growth for us, not only in the US but in Europe and other countries that are faced with the geopolitical situation that exists today. We are operating under continuing resolution in the US, which we're expecting that budget to be signed this quarter, which is favorable for us in terms of the RDT and E-Line items that are getting bipartisan support to progress through this election year. So that seems to be an area for us. And then, the defense modernization, as we've already touched around, there is multiple areas of innovation that involve long-term, short-term programs with the prime contractors, again around MSO space crossing over into commercial sector. So there's a lot of vectors within what we would traditionally call aerospace and defense. Wireline as we just spent a lot of time talking about continues to provide opportunities for us to grow. And then I think as we've mentioned, the automotive funnel, which is quite robust, has programs that are crossing into the next several three quarters and we are actively engaged with all of those. So, I expect that to be a driver of growth for us as well. And we'll watch it and take it a quarter at a time with the headwinds that we're currently experiencing on manufacturing and on semiconductors. But as we mentioned, we saw some growth around memory. That's an early indicator that typically goes first. We expect that to continue to be an area of strength. And of course, we're watching very closely the status of these additional fabs that are in the process of being built out in various places around the world.

Operator:

Thank you. The next question is from the line of Mehdi Hosseini with Susquehanna. You may proceed.

Neil Dougherty:

It was -- ESI was $67 million, $68 million in Q1 a little higher, and so I think the revenue decline Q1 to Q2 in the core is still rounds to 1%. It's just a tick over 1%.

Neil Dougherty:

Yeah. I mean, yes. First of all, ESI was great in Q1. There's significantly 10% or more above our expectation going into the quarter. They saw strong renewal activity as expected with some good upsizing of transactions and other things that drove that revenue nicely. The sequential decline in ESI is totally as expected that we talked about it last quarter, that 40% to 45% of their orders and revenue are falling because their renewal schedules fall on Keysight's first quarter. But it does make the compares a bit more challenging when looking at the combined entity.

Satish Dhanasekaran:

Yeah. The profile -- the timing and the profile of the recovery, Mehdi, as you can appreciate, is hard to really quantify or analytically quantify for you at this point. But let me give you some subjective color on what we're seeing. I think we're seeing continued strength in aerospace, defense. Mark touched upon that. The trends are on defense modernization. The new emulation solutions are continuing to proliferate through that ecosystem. And given the sort of national security emphasis that's playing out, we think that's on a sure track. We also have seen the 5G platform that we have get into some of the more defense-related applications and we announced a collaboration as an example with Lockheed Martin. So, we look at that and we look at the pipeline of opportunities that Mark referenced and feel good about the aerospace and defense. And typically, as you would expect, our aerospace, defense has the strongest quarter in quarter four. So that's one part of the equation. The other thing is what we're hearing from some of our semiconductor customers as the fab companies coming out and laying out their plans for '25 is they're all planning for a pretty strong '25 capital environment around next-generation 2-nanometer technology, and some of the new investments around power semiconductor and silicon photonics and other areas. And so, we would expect some uptick there in our semi business, which has been depressed by the time we roll out in Q4 and entering into Q1. So, it's hard to really time it on a quarterly basis, but that's sort of the horizon that we would expect. We would expect the wireline business to largely continue to perform well because the drivers on AI continue to remain robust. And then wireless, I'm just factoring in a pretty gradual recovery as we go through the year. So that's sort of our base case. Now, there is this whole macro. What does the macro do? And if the global PMI improves quicker, then maybe there's some upside in our general electronics business. But we're at this point just assuming that there isn't this big broad recovery this year or in this fiscal year anyway. We would assume that second half is just modestly bigger in business than the first half. But again, if we go back and look at the situation as we take it a step back, last year was the first year where orders declined double digits. We were still able to use our backlog to deliver revenue -- a stronger revenue -- I mean at least an upside revenue and strong profitability. So now we're coming off of that, this will be the second year when if orders don't rebound, we would expect a strong rebound from our experience historically running this business.

Operator:

Thank you. The next question is from David Ridley-Lane with Bank of America. Your line is open.

Satish Dhanasekaran:

Yeah. Thank you. I think first and foremost, I would say from an organic -- we're an organic-first company. We believe in taking a long-term view of our markets. And what's changed since we formed Keysight is our organization that is focused on customers. So we're getting strong validation around our investments with our customers. So, partnerships and collaborations are key to how we are able to realize the full value of our organic investment. So, we feel very good about where we are focused on from a portfolio perspective and our ability to drive long-term organic growth. Now, having said that, I laid out at Investor Day four or five areas where we are looking at some expansion opportunities. Some of them we're pursuing organically as well, but we're also looking at our pipeline from an M&A perspective and looking for opportunities where we can create good return on investment for our shareholders. You've seen us be incredibly disciplined as we have pursued these opportunities. We walked away from deals where we thought we couldn't get a good return. And so, you can expect that even as we pursue these opportunities and look at the pipeline, we will stay disciplined as we go through this -- as we go through the evaluation.

David Ridley-Lane:

Great. Thank you. And then just a quick follow-up. How are you working on getting the ESI and Keysight sales forces aligned and prioritizing which customers to go after on a joint basis? And am I right in thinking just similar to other software companies, it takes six, nine months to build the pipeline and then another six months to close, so those benefits, we should think of showing up maybe in fiscal '25?

David Ridley-Lane:

All right. Thank you very much.

Operator:

Thank you. The next question is from Rob Mason with Baird. You may proceed.

Neil Dougherty:

Yeah, it's a good question. And there are a few things. So, first of all, we had a very favorable mix within the quarter in Q1, not just because ESI was in at $67 million or $68 million of revenue on software, but even within the Keysight classic portion of the business, we were north of 66%, so very favorable in the core as well. We do not expect to be mixed to be as favorable next quarter as it was or frankly -- probably for the rest of the year, mix is unlikely to be as favorable as it was in the first quarter. And the other thing would be from an OpEx perspective, we do expect Q2 OpEx to be seasonally higher, that is typical. And the single biggest factor to that is PTO usage. PTO usage is the lowest in the second quarter of our fiscal year, and that's enough to drive a measurable increase in OpEx as we move from Q1 to Q2.

Rob Mason:

Yeah, certainly. Just as a second question. There's -- during the quarter, we saw more, I guess, some of your EDA and simulation participants in the market converging. I know Keysight has some strategic partnerships with some of the players involved there. I'm just curious how you think consolidation around those areas affects your opportunity? And maybe you could speak to any of the test layers that would be more impacted or not? And really just kind of getting at how do you define Keysight's moat in this backdrop where you're seeing some of the simulation converge?

Rob Mason:

Very good. That's helpful. Thank you.

Operator:

Thank you. There are no further questions in queue. With that, I would like to turn the call back over to Jason for concluding remarks.

Operator:

That concludes today's conference call. Thank you for your participation. You may now disconnect your lines.

Operator:

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Fourth Quarter 2023 Earnings Conference Call. My name is Sarah, and I'll be your lead operator today. [Operator Instructions] This call is being recorded today, Monday, November 20th, 2023 at 1:30 P.M. Pacific Time. I would now like to hand the call over to Jason Kary, Vice President, Treasurer and Investor Relations. Please go ahead.

Satish Dhanasekaran:

Good afternoon, everyone, and thank you for joining us. My comments today will focus on three key headlines. First, Keysight reported solid fourth quarter results and finished the year with record revenue, gross margins and operating margin, in what remains a challenging macro environment. Fourth quarter revenue and earnings per share exceeded the high end of our guidance, as orders came in slightly ahead of expectations. For the full year, revenue grew 2% on a core basis and earnings per share increased 9%, while we generated $1.2 billion in free cash flow. Second, our customer engagement on next-generation technology teams remain strong and we continue to action opportunities, across a broad and diverse set of end markets. Despite the mixed demand environment, as end markets normalize from post-COVID supply demand imbalances over the last two years. Third, we're investing both organically and inorganically, to expand our addressable markets and differentiated solutions portfolio, which took other step forward this quarter with the addition of ESI. We remain confident in the long-term secular growth drivers of our business and our ability to address our customers' most challenging and diverse innovation needs. Now let's begin with a brief overview of Keysight's fourth quarter and full year performance. We're pleased with our results and execution. Fourth quarter orders were $1.3 billion, and we delivered $1.3 billion in revenue and $1.99 in earnings per share. We also generated $340 million in free cash flow and repurchased $426 million of our shares this quarter. Full year results were strong in a year of normalizing demand. Orders of $5.2 billion were in line with our original expectations of approximately $1.3 billion per quarter this year. We delivered an all-time high of $5.5 billion in revenue and achieved record profitability with gross margins of 66% and operating margins of 30% and $8.33 in earnings per share. Moving to our markets. Overall, the demand dynamics within the quarter, were consistent with our expectations. Aerospace, Defense and Government demand increased, commercial communications was steady and as anticipated, broader manufacturing-related spending in the electronics industrial markets was incrementally softer. Turning to our business segments. Communications Solutions Group revenue declined 10%. Aerospace, Defense and Government grew, while Commercial Communication markets are rebalancing off of last year's record highs. On a sequential basis, orders grew across both markets. In Aerospace, Defense and Government, revenue grew 4% to an all-time high, we saw healthy order demand from the US and European primes, as well as direct government customers, driven by investments in Defense modernization, space and satellite applications. Keysight's Leading Threat Emulation solutions capabilities drove order growth in the US, including a large US Department of Defense win for electromagnetic spectrum operation applications. We also saw demand from European primes for our Radar and phased array antenna solutions to support their delivery goals in 2024 and beyond. The breadth and the depth of our solutions portfolio enable new customer engagements and business in satellite communications 5G and 6G and advanced quantum research, including a large order from a premier research institute contributing to the record quarter. In Commercial Communications, revenue declined 17%, reflecting ongoing customer spending constraints, as inventories in their markets normalize. Sequentially, we saw stability in wireless orders and incremental strength in demand for network and data center applications. Demand for our wireline solutions was driven by AI ML and data center expansion, as hyperscalers build infrastructure to handle increasing network and compute workloads. We expect this trend to continue into the next year and beyond. Enterprise customer business was stable with ongoing investments in network monitoring, driven by increasing data traffic and cybersecurity compliance needs. In Wireless, the progression of standards is driving steady R&D investments in new capabilities and devices, as well as Open RAN and Release 17 features. Our R&D engagements with customers continue to expand. This quarter, we enable MediaTek to validate non-terrestrial network connectivity. In addition, Keysight was awarded two key UK government grants in partnership with universities and leading telecom operators to support Open RAN design, testing and deployment in Europe. Turning to Electronic Industrial Solutions Group. As expected, Q4 orders and revenue were both down compared to record levels of last year. It is important to note that the EISG has shown significantly about long-term expectations with revenue increasing by 30% in 2021, 14% in 2022 and an additional 10% in 2023. This growth was driven by both our Differentiated Solutions portfolio and an outsized demand from post-COVID recovery and supply constraints. In the second half of this year, we began to see a normalization from these size as well as ongoing cautious customer spending. In semiconductor, capital spending for wafer capacity contracted in the quarter, as foundry customers pushed out their new fab investment time lines. We continue to see strong customer engagement for Keysight's proprietary interferometer systems and differentiated R&D solutions for silicon photonics and power semiconductors, reflecting the industry's medium to long-term recovery and growth expectations. In automotive, customer investment in R&D for battery and charging infrastructure continues and is being fueled by increasing competition, regional legislative deadlines and government funding, particularly in Europe and Asia. The funnel of EV opportunities remain strong, while the timing and size of these systems engagements are expected to vary from a quarter-to-quarter. In General Electronics, we saw steady demand for our solutions in advanced research, industrial automation and digital health. However, and more broadly, manufacturing capacity normalization and cautious spending continued to weigh in on consumer electronics and manufacturing portions of the market. We're watching Global PMI and other macroeconomic indicators to gauge the timing of the market recovery. As an integral part of our solution strategy, software and services revenue growth this year continue to outpace Keysight overall. The recurring portion of software and services grew 9% this year, driving total annual recurring revenue to approximately $1.3 billion or 23% of total revenue, an increase of 200 basis points, year-over-year. In early November, ahead of schedule, we announced our acquisition of a controlling block of shares of ESI Group. The addition of ESI, further increases our software and annual recurring revenue expands our addressable markets and strengthens our strategy of moving upstream into earlier stages of our customers' design cycles. We continue to invest prudently to capitalize on our long-term growth opportunities. In parallel, we remain disciplined and are taking additional targeted cost actions to streamline operations and ensure strong financial performance. In wrapping up my first full year, as the CEO of Keysight, I'd like to thank our employees for their outstanding contributions, commitment and strong track record of execution in these tough market conditions. The strength of Keysight's differentiated solutions, the diversity of our end markets and the durability of our business model, all position us well for continued market outperformance, as we enter the new fiscal year. With that, I'll turn it over to Neil to discuss our financial performance and outlook.

Jason Kary:

Thank you, Neil. Sarah, will you please give the instructions for the Q&A?

Meta Marshall:

Great. Thank you. Maybe first question, you guys talked about kind of an over-performance of EISG or how well that business had done over the last couple of years. Just trying to get a sense of, is there a period, where you think kind of represents, the run rate of that business just as we think of the growth of that business going forward? And then -- maybe just the second question, just on the Communications business. You guys have mentioned kind of seeing stabilization in that business. So I just wanted to kind of clarify that none of the weakness that you are seeing has kind of spread to more of the lab testing that it's largely kind of stayed on the production side. Thank you.

Meta Marshall:

Great. Thank you.

Operator:

Our next question comes from Samik Chatterjee with JPMorgan. Please proceed.

Neil Dougherty:

Yes. So I do think you interpreted the comments correctly. I think as we move from Q1 to Q2, we do expect a low single-digit increase in core Keysight. But ESI, as we mentioned, because of the timing of their contract renewals, recognized as a disproportionate portion of their revenue in Keysight's first quarter, 40% to 45% with the balance 55% to 60%, spread roughly evenly over the subsequent three quarters. So there is a significant drop off on the ESI side of things, just given the timing of those contractual renewals. I think, obviously, we're taking this one quarter at a time, given the normalization that we're seeing in the marketplace. I do think that over time, we expect the seasonality of the Keysight business to return more towards historic norms, than what we've seen over the last couple of years, as a result of the supply chain disruptions, but we'll have to wait and see how that develops as we move forward.

Neil Dougherty:

Yes. So we've shared the same essentially, model describing kind of demand normalization here, really since our spin. And that's a model that says, if our revenues are down 10%, that we would expect operating margins to be down 300 to 400 basis points in that scenario. That's obviously pre any acquisition activity. So when you think about layering in ESI, obviously, it's a public company, you can look at their results. At this point, we only own half the shares. It's going to take us a while to get to full ownership. So I think you can layer in ESI in the short run, much as they were -- as they were running as an independent company. And once we get to full ownership, we'll be able to really set our minds on cost reduction within that space, synergy realization.

Operator:

Our next question comes from Rob Mason with Baird. Please proceed.

Neil Dougherty:

Yes. So first of all, as we said last quarter, they were about 8% of orders to date, and that's where they finished. So Q4 was on par with the first three quarters of the year, and that compared to we're like 2% as a historic run rate. The majority of that revenue will be in '24, although there is a portion, a sizable portion that pushes out into '25.

Neil Dougherty:

It's a mix. I think earlier in the year, those orders skewed towards EISG, not surprising with the strength in Aerospace, Defense and Government fiscal year-end. In the fourth quarter, they were more skewed towards Aerospace, Defense end market. So it really is a mix.

Neil Dougherty:

Yes. It really depends on what happens during this tender offer process, which again, we expect to complete the tender in the calendar first quarter. I think if we do that, then we'll move immediately and that goes as expected, we'll move immediately to a squeeze out that I think would have us complete mid-year. There are scenarios, where if less than the required number of people get to tender, where it will take us a little bit longer to meet the appropriate thresholds to essentially do the squeeze-out process.

Satish Dhanasekaran:

Thank you.

Aaron Rakers:

Yes. Thanks for taking the questions. I want to go back to the prior question on kind of the longer backlog metric. I think last quarter, you talked about that being $200 million. Is that -- I know you said 8% of orders, but is that still that -- roughly that number, which should be on top of the $2.3 billion or so total backlog you came out of exiting this last quarter?

Aaron Rakers:

And to be clear, that will, typically, your backlog was a six-month forward number. It sounds like a majority of that would be recognized in the back half of the fiscal year. That's a fair assessment?

Aaron Rakers:

Okay. Perfect. And then the real quick follow-up is, could you talk a little bit about what you're seeing on Wireline with regard to AI? Just maybe flesh out exactly where you're involved? Because it seems like that is -- clearly, as we move towards possibly Ethernet and 800 gig, it seems like that would be inflecting. I'm just curious to how Keysight's involved in that?

Aaron Rakers:

Thank you, guys.

Operator:

Our next question comes from Chris Snyder with UBS. Please proceed.

Satish Dhanasekaran:

Yes, maybe at the highest level, I would just say, we got a sequential improvement, I would say, in orders from our Aerospace, Defense business, which was strong. Obviously, the year-end is typically what we expect. We saw that for Commercial Communications, sequential growth, stability in Wireless/5G and a sequential uptick in our Wired part of the ecosystem. And what we anticipated also was, we would see some softness in the EISG business, particularly with Asia and China, and we did experience that. Now again, to put it in context, the EISG business is just later in undergoing this demand normalization. And so that was what we had sort of forecasted, and so it behaved as we expected. With regard to the Wireline Ecosystem, I just go back to our long-term growth rate expectations for the Communications business in general and say that we see a business that is diversified, where multiple technology waves are overlapping. And that gives us inherent stability and resilience, and we're pleased by some of the progression we're seeing in the AI ML spend, because we've been working with customers on this for some time now. And we expect that as more of the network traffic is driven by applications that are coming out for AI ML, this will become a bigger part of our business. I'll just maybe hand it off to Mark to make some comments on orders.

Christopher Snyder:

I appreciate that. And then for my follow-up, I guess maybe more of a modeling question. For the revenue, Q1 revenue guide, the $1.245 billion at the midpoint, does that include $60 million from ESI implying about $1.285 billion at the midpoint for organic Keysight. It seems to be a pretty sharp fall off versus the 1327 orders we just got. Thank you.

Christopher Snyder:

Thank you.

Operator:

Our next question comes from Mark Delaney with Goldman Sachs. Please proceed.

Satish Dhanasekaran:

Yes. Thank you, Mark. Absolutely, we are confident in the long-term outlook for the business, I outlined at Investor Day several overlapping themes of technology waves that are playing out across end markets. And our view remains solid with that. In fact, as we engage with customers even through this time, where the spend has been lower, customers are intensely focused on higher priority R&D programs. And so that strategic view has not changed for us. Obviously, there is this current demand normalization that's occurring after fiscal '21 and '22, where we had outsized order growth in the business. And so post normalization, we remain confident in our ability to continue to grow the business, because of these multiple ways of technology across both wired and wireless ecosystem.

Mark Wallace:

Yes. No, we remain active in all of the markets that we serve. The automotive market, in particular, continues to be quite robust with many customers investing in long-term EV projects, which we continue to engage with. So no, we've not seen any change since any recent announcements.

Operator:

Our next question comes from Adam Thalhimer with Thompson Davis. Please proceed.

Satish Dhanasekaran:

Yes. Thank you. I'll have Mark make some comments, but thank you. We're pleased with the execution and the operational performance of the business in fiscal '23. Our engagements in China with customers remain strong, but I'll have Mark make some comments by end market.

Adam Thalhimer:

Okay. Thank you, Mark.

Operator:

Our next question comes from Atif Malik with Citi. Please proceed.

Satish Dhanasekaran:

Yes. Thank you. I think at the highest level, the things, that I watch for are the continued progression, the smartphone industry is making in inventory reductions, right, that's been talked about for chips and final device form factors. So that's one thing we watch. Obviously, when we think about the 5G standards progression, what we're seeing so far is increased interest from customers in Open RAN, even in our 5G business this year, Mark and team have added new customers to our already strong mix of installed base customers. So our leadership position continues to remain strong and we're continuing to remain differentiated with our portfolio, which is very broad and cares to the need of the entire ecosystem. The area that has also gained a lot of importance, as we went through the last year, has been the non-terrestrial networks so the satellite cases with 5G. And we're also seeing some interesting new use cases associated with Release 17 and the research interest across the globe to build organic IP in what comes beyond 5G has already kicked off and Keysight continues to play an early role in partnering with these customers. So when we look at our investment priorities. Yes, we're investing in R&D, but and we're focused on that -- focusing that investment around these next-generation themes, which will continue to enable us to be strong and grow the business over the long run at the rates that we've put out at the Investor Day.

Neil Dougherty:

On Core Keysight, we would typically see a sequential increase, as you move from Q1 to Q2. I think we'll need to wait for some time to pass, but to give you a sense of how that increase is going to compare to historic norms. But typically, you would see a Q1 to Q2 increase. And I think based on everything we see at this point, that's what we expect.

Neil Dougherty:

Thank you.

Matthew Niknam:

Hey, guys. Thank you for taking the questions. I have one follow-up to a prior question and one other one for Neil. In terms of the follow-up. So we're talking about a softer than seasonal outlook for Core Keys, stripping out that 60-ish million from ESI in fiscal 1Q. Is that primarily EISG i.e. are their expectations for more relative stability to sustain in comms and some of the strength to persist in ADG? So more just sort of unpacking that outlook for fiscal 1Q, across the segments? And then maybe for Neil, you're talking about CapEx of about $150 million. I think at the Analyst Day, it was around a $225 million mark for fiscal '24. I'm just wondering what's changed?

Neil Dougherty:

Yes. On the CapEx, I mean, obviously, the business has been softer this year than we expected. And so when you think about investments in capacity and those types of things, we have either canceled in many cases or delayed other programs in response to the current macro environment, which is resulting in the reduced expectations for CapEx going forward.

Neil Dougherty:

In '24. You're welcome. Thank you.

Tim Long:

Thank you. Two, if I could. First, on the Wireline side, could you talk a little bit more specifically about optical kind of what you're seeing there? Where are we in cycle, it's been a little bit more challenged with some of the companies in the ecosystem. So if you could just talk about what you're kind of seeing on the physical test side, as well as Ixia. And then, just the second one on the Defense Automation business. It seems to be continuing rolling along really strong. Could you talk a little bit about sustainability of that kind of defense line, over the next multiple quarters? Thank you.

Mark Wallace:

Yes. There's not much to add. Satish has covered it well. But what we've seen is this pattern of R&D and manufacturing on the wireline side. And we saw an uptick in 800 gigabit manufacturing spend for optical transceivers, feeding into network build-out and data center upgrades. So we saw a sequential improvement and the funnel would support that continuing. We saw AI server and GPU infrastructure testing also on the physical side. So there's some demand growth there. And as you pointed out, our broader portfolio in protocol solutions was reflected in some of our network visibility growth, particularly from enterprise customers. So these are all strengths that we were able to capture during Q4.

Operator:

Our next question comes from David Ridley-Lane with Bank of America. Please proceed.

Neil Dougherty:

You should be able to bridge from the Q4 results that we just put up to the Q1 guide, even if you adjust for the ESI, really with two bridging items. The first is the increase in the tax rate from 12% to 17%. And the second is the implied reduction in revenue, right, which we just talked about, goes from $1,311 million to $1,185 million so about $125 million reduction in revenue should be sufficient to bridge the delta.

Neil Dougherty:

I'm not sure I follow your question. If people are pushing out and we have confidence that they're ultimately going to take delivery of product, generally speaking, we leave those orders on the books.

David Ridley-Lane:

It was revenue and so if it was an order that tied to a semi fab, where the construction itself got pushed, that status orders, and you would just recognize the revenue later.

David Ridley-Lane:

Yes.

David Ridley-Lane:

Thank you very much.

Mark Wallace:

Thank you.

Jason Kary:

Thank you, Sarah, and thank you, everyone, for joining us. Just to wrap up the call, I'll turn it over to Satish, and over to you.

Operator:

That concludes our conference call. You may now disconnect your lines.

Operator:

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Third Quarter 2023 Earnings Conference Call. My name is Cole, and I'll be your lead operator today. [Operator Instructions] This call is being recorded today, Thursday, August 17, 2023 at 1:30 P.M. Pacific Time. I would now like to hand the call over to Jason Kary, Vice President, Treasurer and Investor Relations. Please go ahead, Mr. Kary.

Satish Dhanasekaran:

Good afternoon, everyone, and thank you for joining us today. Keysight reported solid results in the third quarter, demonstrating the strength of our portfolio and the resilience of our financial model. We are executing on our strategy and delivering on our commitments to customers and shareholders in a challenging macro-environment. My comments today will focus on three key headlines. First, we delivered another quarter of strong financial performance demonstrating Keysight's diversified portfolio, strong execution, and operating discipline. Third quarter revenue was in-line with our expectations, while record earnings per share exceeded our guidance range. Second, while orders came in at the low end of our expectations, we saw positive and steady customer R&D spending and continued stability in commercial communications. Growth in aerospace, defense and government and growth in our automotive EV and AV solutions, partially offsetting incremental softness in EISG and Asia, primarily related to semiconductor and other manufacturing. This backdrop has tempered our near-term expectations for orders and revenue. We've factored this dynamic into our outlook for Q4, while now expecting full-year EPS growth of 7%. Third, despite the near-term challenges, Keysight's diversified business, differentiated solutions, and durable operating model give us confidence in our ability to capitalize on the long-term secular growth trends of our markets, as well as outperform in a variety of market conditions. Now let's take a deeper look at our third quarter results. While orders declined 15%, revenue of $1.38 billion was up 1% on a core basis and a record for the third quarter. Our differentiation and strong execution resulted in gross margin of 66% and record operating margin of 31%. We delivered $2.19 in earnings per share, which was an all-time high. Turning to the demand environment, we continue to see steady investment in strategic R&D programs in commercial communications, aerospace, defense and government and automotive EV solutions. In fact, over the past year, we've seen a meaningful growth in large long-term customer commitments related to strategic programs, particularly in automotive and ADG. We view this as an important validation of our strategy, it puts us in a strong position in key emerging technologies and positions us well for future growth. Demand was incrementally weaker in Asia this quarter as customers deferred manufacturing-related spending in semiconductor, general electronics, and automotive markets in many cases well into next year. Taken together, the increase in our customer strategic program investment combined with soft near-term demand environment is moderating revenue in the fourth quarter, which Neil will discuss in more detail. Turning to our business segments. Electronic Industrial Solutions Group revenue grew 14% to another quarterly record and the 12 consecutive quarter of double-digit revenue growth. The strong financial performance was driven by double-digit growth across all markets and regions. EISG orders in the third quarter trended lower, particularly in semiconductor and manufacturing. Our customer engagements remain high as they're planned for, and continue to invest in key long-term strategic initiatives. In semiconductor, despite a near-term pullback in capital spending for wafer capacity, the industry is marching forward and planning for a strong future demand environment. In the near term, customers are prioritizing new applications such as silicon photonics to address the AI demand. As a result, this quarter we did see significant slowdown in our new wafer test solutions, while demand for Keysight's silicon photonics test and proprietary interferometer systems remained high. We expect these dynamics to continue over the next few quarters. In automotive, investments in EV and AV technologies continued to be strong. This quarter we secured a third strategic win with another large European OEM to supply an EV battery test system that includes our PathWave Lab automation software. This program will be implemented in 2025, and we're quite excited to be working with industry leaders and supporting their goals. To address customer needs for wireless tracking, diagnostics and connected vehicle communications, Keysight also announced support for automated RF testing for Autotalks’ C-V2X chipsets on our PathWave Test Executive software platform. In general electronics, the growing collaboration between universities and companies is driving further investment in our solutions for advanced research. We're also expanding on our customer engagement in digital health solutions to support the growing digitalization and connectivity requirements of this industry. Turning to Communications Solutions Group, revenue declined 5%, while the overall stable demand environment continued quarter-to-quarter. Aerospace, defense, and government revenue grew 11% with strong demand from U.S. government and primes. Keysight's differentiated signal generation and threat scenario emulation capabilities led to a large U.S. Air Force contract in Q3. We also won a key contract from leading Canadian prime contractors for electromagnetic spectrum operation applications. In addition, the demand for our radar and defense modernization solutions grew robustly as prime contractors placed orders for systems that support their delivery goals in 2024 and beyond. Government research demand and investment in 5G and 6G continued as well. Commercial Communications revenue declined 12% due to cautious spending by customers and weaker manufacturing activity in smartphone, PC, and component supply chain. Customer engagements remained strong with R&D investments in key technology to support 5G and 6G AI/ML-driven high-speed datacenter networking and satellite communications. Demand for our wireline applications improved sequentially driven by cloud provider and hyperscaler investments as they designed their networks for AI and ML workloads. Enterprise customer and key service provider investment was steady, driven by increased digitization, heavier network loads, and rising cyber security concerns. In wireless, 5G standards are progressing and we saw steady R&D investment in Open RAN, satellite, non-terrestrial networks and 5G RedCap Release 17 capability targeted at industrial and IoT applications. Early 6G engagements continued this quarter. We enabled the University of Stuttgart to advance 6G integrated circuit research with our sub-Terahertz solutions. Keysight also led the agreement between the 6G-SANDBOX consortium and the European Space Agency to further research to integrate terrestrial 5G/6G technologies and satellite networks of the future. This quarter, we continued to strengthen our technology leadership in the industry and enable our customers' innovation. For example, we extended our flagship network analyzer portfolio by introducing industry's first integrated platform with vector component and analysis capabilities for power amplifier and component design applications. We also announced industry's most comprehensive multi-speed ethernet performance platform supporting data center interconnects up to 800 gigabit ethernet that are critical for data-intensive applications such as AI. And lastly, Keysight enabled 3GPP protocol conformance validation for Release 17 non-terrestrial networks and is continuing to partner with new satellite operators like Skylo to accelerate the deployment of satellite networks. Software and services remain an integral part of our solution strategy and again accounted for one third of total company revenue. Overall, software and services revenue grew year-over-year reflecting the continued expansion of our software-centric solutions. We remain confident in the long-term secular growth of software intensive R&D applications, particularly earlier in our customers' development process. In line with this trend and the software system simulation opportunity that I laid out at our March Investor Day, this quarter we announced our intent to acquire ESI Group, a leader in virtual prototyping solutions for the automotive and aerospace markets. The addition of ESI broadens our software capabilities into physical simulation and furthers our strategy of moving upstream into earlier stages of our customers' design cycles Keysight's technology leadership and deep collaboration with industry players remains a significant competitive advantage. Despite current macro uncertainty, we see continued investments in R&D driven by multiple waves of technology innovation and broad-based industrial digitalization and connectivity needs. While continuing to invest in these long-term secular growth trends, we remain disciplined and have driven incremental cost efficiencies throughout the organization this year. Our current guidance expectations are to finish the fiscal year 2023 with 7% EPS growth and 1% revenue growth. We believe this financial performance exemplifies the strength of Keysight's differentiated first-to-market solutions portfolio, our durable and resilient business model, and our winning culture which altogether positions us well for continued market outperformance. With that, I'll turn the call to Neil to discuss our financial performance and outlook.

Jason Kary:

Thank you, Neil. Cole, please give the directions for the Q&A.

Samik Chatterjee:

Yeah. Hi, so many thanks for taking my question. Hi, Satish. Can you hear me?

Samik Chatterjee:

Hi. Can you hear me? Yes. Hi.

Samik Chatterjee:

So, if we can start with EISG where you said demand trends or order trends are stable. Maybe if you can sort of dig into that a bit more because there have been concerns given that the smartphone ecosystem still remains really sort of below average in terms of demand that there could be further weakness there. What are you seeing in terms of wireless versus wireline, particularly interested in understanding if you're seeing any demand uplift from all the uptakes in the AI applications on the wireline side? Just maybe dive into that a bit more. And I have a follow-up. Thank you.

Samik Chatterjee:

Yes, please. Thank you. Thanks for that. For -- relatively sort of again thinking in relation to orders and if orders -- sort of your thoughts on what orders -- what we need to see in terms of orders going into next year for Keysight to be able to get back to the long-term growth outlook that you have on the revenue side, particularly in relation to, I think, historically, your orders and revenues have been pretty tightly correlated. So how you're thinking about what you need in terms of orders? And maybe one thing to clarify is, I didn't really fully comprehend the implication of what Neil is mentioning in terms of more long-term strategic orders from your customers. Is that necessarily a divergence between sort of what you would see on order trends versus that translating into revenue next year? Any thoughts on that, please?

Neil Dougherty:

Yes. Hi, Thanks, Samik. Yes, so as you think about orders, obviously, through the first quarters of this year, we've been able to run revenues at a level that was materially higher than the incoming order rate as we work through some of the backlog that we built up over the COVID period of time and then the supply-chain disruptions of the last 12 to 18 months. And as we look-forward, we've seen this degradation in the demand environment this quarter that is going to put some pressure on orders as we move into Q4 and likely into Q1. And so, our ability to continue to drive revenue based on backlog is becoming incrementally challenging, right? We've burnt about $300 million -- burnt through about $300 million of backlog so far this year, that's the rate at which revenues have outpaced orders. And then I talk about this change in mix towards longer-dated system, so it is a small portion of our business, which we haven't talked about much because it's been consistently less than 5% where we're working on larger-scale strategic programs that are delivered over an extended period of time to our customers. And we view it as very positive that our customers are continuing to invest in those kinds of projects, that portion of our business was roughly 2% of orders through three quarters last year, it's about 8% of orders through three quarters this year. And what that essentially means is an addition to the $300 million we -- a backlog we burnt, we've taken another $200 million of short-dated backlog and turned it into long-dated backlog. And so, as you think about our guidance for Q4, it's essentially built on the scheduled backlog that we have set to deliver into the -- into next quarter, and our own view of orders for the coming quarter and our ability to turn a portion of those orders into revenue within Q4.

Samik Chatterjee:

Got it. Thank you. Thanks for taking my questions.

Operator:

Our next question is from Mehdi Hosseini with SIG. Your line is now open.

Neil Dougherty:

Yeah, Mehdi, I think that's largely correct, right. I've talked over the past year about the fact that we felt like we had built -- excuse me $400 million to $500 million what I call abnormal backlog. And as I just stated, we burnt through $300 million of that through three quarters of this year and then we've essentially converted another $200 million of essentially short-dated turns backlog into backlog for these long-dated programs. So I view that we've materially worked through that abnormal backlog at this point and I don't think it's unrealistic to assume that in this environment our kind of normalized backlog level will have a two handle on it.

Mehdi Hosseini:

Okay, great. And my follow-up has to do with the semi-mix. I think you mentioned that the semi-bookings or new orders were weak in the quarter. Is that due to the delayed ramp of tape-outs for 3 nanometers? And if that's the case, should we assume a rebound in semi-related orders as we start with the new fiscal year, fiscal year 2024?

Mehdi Hosseini:

I just want to understand would increase 3-nanometer tape-out next year have a positive impact for your semi-business?

Mark Wallace:

Yeah. Hi, Mehdi. What I can say is that despite the pullback in the short-term, the engagement with our customers on advanced process technologies, including 3-nanometer, 4-nanometer, 2-nanometer have continued. And many of these customers are looking at a variety of aspects of their market as well as managing their financials. A couple of examples, one is we have a customer in the US that has delayed some of the fab build-out because of construction issues. So we expect that to -- we will correct itself in the next couple of quarters. We have another customer, again, working on these advanced node sizes and technologies, who has locations in the US and in Asia, and they're maintaining their total project plan and investment, but spreading the CapEx over several quarters. And there's a lot of those stories. So, it really feels to me like we are going through a phase of pullback. But the answer to your question is, yes, we expect this to positively impact our business in 2024.

Operator:

Our next question is from Aaron Rakers with Wells Fargo. Your line is now open.

Neil Dougherty:

Yes. No, it's a fair question. So first off, do we believe backlog has normalized, and I'd say the answer to that is largely, yes. We believe backlog has normalized at this point. With regard to incoming order rates and seasonality, you're absolutely correct. We typically see a pretty sizable increase as we move from Q3 to Q4 at the end of our fiscal year and what I would say is, we do expect orders to be up sequentially from Q3 to Q4. But we expect a significantly smaller sequential increase than would be typical based on weakness of the funnel that materialized during the third quarter.

Neil Dougherty:

Yes. I mean, I guess, I would think of it as with backlog having normalized, we would expect orders and revenue to start to converge.

Satish Dhanasekaran:

So let me take that, and Neil if you have anything to add, you could. First of all, I would say, it's a great strategic fit, one we're very excited about. I think you've heard me describe the system simulation and emulation opportunity as a near adjacency to the work that we do with customers, especially as we have focused the strategy on engaging with customers early and in their R&D workflows. So the addition of ESI really is a great fit there. Financially, it's accretive to our gross margins, it will be when we close the transaction. And we also think it will be accretive to our [SOFR] (ph) percentage by at least two points at the company level. And from a cultural perspective, I think it's very important as well. ESI is a company that's been around for 50 years and has been involved in some of the most complex simulations associated with crash testing and other areas. And I think with the -- by coming into Keysight and what's exciting is the combination of that can now not only provide go-to-market capabilities that can further accelerate growth but also engage with customers in new applications in aerospace, defense and other end-markets leveraging the deep technology expertise of ESI. So very excited by this transaction as we announced it. Thank you.

Operator:

Our next question is from David Ridley-Lane with Bank of America. Your line is now open.

Satish Dhanasekaran:

Yes. I think some of it is the implementation of our solutions approach to what was otherwise markets that we had maybe sort of purely through the lens of products historically. I think of aerospace, defense, David, as an industry, where we largely sold instrumentation tools. And over the past few years, we've put focused effort to adding more value to the customer base by integrating the instruments, but also layering on software and creating more services opportunities. So some of it is a function of the go-to-market push that we've had, but also equally the acceleration in demand we see in specific areas such as automotive. And I'll have Mark maybe give you a couple of more examples to make a drill.

David Ridley-Lane:

Thank you. Thank you for that. And then just on the fourth-quarter guidance, I think the kind of implied incremental margin is quite high. Is there something unusual about the margins in the fourth quarter this year?

David Ridley-Lane:

Got it, okay. Thank you very much.

Operator:

Our next question is from Matthew Niknam with Deutsche Bank. Your line is now open.

Neil Dougherty:

Yes. So, obviously, we'll give you more color on FY 2024 here in three months. But obviously, we spent a fair amount of time thinking through it ourselves. And as you noted and as I've noted, through the first three quarters of FY 2023, we were able to drive revenue at a level that was significantly above the incoming order rate. As a result, we're going to have some difficult revenue comps as we enter 2024. As I'm thinking about the transition from Q4 into Q1, at least right now, I'm thinking about kind of the typical seasonal decline that we would see on the revenue line as we move from one period to the next. And then I think as we look forward beyond that right now, we don't see a catalyst right now that is going to drive a significant market recovery in the first half of the year. But I think we're looking to a recovery in the second half of the year because as Satish has said, we believe that much of what's impacting our markets at this point is temporary in nature, right? Our commercial communications customers are going to work through their inventory challenges, the major investments that we're seeing in fab capacity they've been delayed, but they're still moving forward and that includes investment for the insurance of supply for 2 and 3-nanometer, silicon photonics, silicon carbide, all of that stuff is moving forward. And on the technology side, their R&D investments continue, right? We're going to see additional standards releases for 5G, continued investments in 6G research, AI, quantum, AV, EV, all of that stuff is moving forward. With regard to EPS outlook again, tough, tough, tough revenue comps, but we're a disciplined organization, the flexible business model you've seen that in the results that we published year-to-date. I think going forward the challenge for us is to maintain balance, right? We're optimistic about the long-term, we're going to continue with the investments that are going to enable us to fully participate in the recovery when it happens, while at the same time relying on our discipline to drive EPS growth. We're certainly working to offset whatever tax impacts we can, but as you noted, the tax impacts are significant.

Matthew Niknam:

That's great. Thank you, both.

Chris Snyder:

Thank you. So, I very much appreciate that the softer orders and the backlog burn is leading to the softer sequential revenue from Q3 to Q4. But I wanted to ask about the sequential margins. It seems like the guide puts margins maybe in the mid-28, so down 250, 300 or so basis points year-on-year -- sorry, sequentially. So looking at 80% sequential decremental, it seems very steep. Can you just maybe talk through why that margin fall off is so sharp sequentially? Thank you.

Chris Snyder:

I appreciate that. Thank you. And then I appreciate the guide on the tax next year for the non-GAAP 15% to 17%. I just wanted to -- I guess maybe a housekeeping one. Is there any change in the cash tax rate when we think about 2024 versus 2023? Thank you.

Chris Snyder:

Thank you.

Adam Thalhimer:

Hey, good afternoon, guys. The revenue guidance for Q4 of minus 10% at the midpoint, do you see both segments down? Can you just help us on how that plays out between the segments?

Adam Thalhimer:

Okay, helpful. And then in aerospace and defense, can you talk at all about the outlook there? It's been a well-timed acceleration offsetting some weakness in communication. Just wondering if the aerospace and defense can stay as strong.

Adam Thalhimer:

Thanks, guys.

Meta Marshall:

Great, thanks. Maybe first question for me, you guys have talked about a lot of new kind of extension areas that you're seeing traction, and particularly on the AI side. With the flat OpEx that you've noted, just wanted to get a sense of how you're making sure of kind of touch base with some other new customers that might be entering into this space or how you're finding better leverage through channels. And then as a second question, just as a reminder on the Communications Group, can you just kind of lay out what you would consider as kind of rough percentages of kind of maintenance standard, so 4G you're kind of existing 5G versus kind of the next-Gen portfolio. Thanks.

Meta Marshall:

Great. Thanks.

Mark Delaney:

Yes. Thank you for taking the questions. Follow-up question as it relates to 800-G ethernet and some of the AI activity you're seeing. You mentioned some orders already on that front, but you described it is still in the relatively early phases. Do you have a sense of when 800-G orders related to AI or are there reasons 800-G may become more meaningful?

Mark Delaney:

That's helpful, Satish. Thank you. And then on the ESI acquisition you made some comments already that were helpful, including the gross margin accretion. I apologize if I missed this. But can you talk a little bit more in terms of what it may mean in terms of EPS contribution when it's integrated and how is that progressing over time? Thank you.

Mark Delaney:

Got it. Thank you.

Operator:

Our next question is from Rob Mason with Baird. Your line is now open.

Satish Dhanasekaran:

Yes. I would say -- yes. Thank you. I would say, again, this is a very small part of our business historically, so we've never had to speak about it. As a function of the lower order levels today, the presentation appears higher. But I'd -- so no change to our order acceptance policy, other than these are complex systems which requires a start work today by inventory and staff people to deliver to our customers. So they are on the books for the right reasons. They're high-quality deals that we feel good about.

Rob Mason:

Understood. And just as a follow-up. Satish, the -- certainly ESI Group, certainly makes sense from the standpoint of moving upstream and staying very close to R&D and into simulation. But I'm just curious how do you think about the opportunity set beyond kind of core electrical engineering customer base, this is around more physical test. Do you start to -- it was ESI unique in that regard or do you start to look more broadly at things outside of electrical engineering test?

Mark Wallace:

I would just add one thing to the exciting part is the alignment to the verticals, automotive, aerospace, defense, it's broadening our footprint and broadening our value to these important customers.

Operator:

Our next question is from Atif Malik with Citi Research. Your line is now open.

Satish Dhanasekaran:

Yes. I think I've mentioned -- Adrienne, hi, a good question. Our Americas business grew quarter-over-quarter -- in Q3, and Europe was stable.

Satish Dhanasekaran:

Year-over-year.

Mark Wallace:

Yes, Adrienne. I think it's a combination, as I mentioned before, these strategic first-time wins with the automotive OEMs into themselves are long-dated and enlarged. And through the process, we work with the customers to up-sell and cross-sell capabilities and then get more visibility across other parts of the groups as they're oftentimes organized or across the ecosystem as well. So I think the way to think about it in its simple terms is these longer-term programs are about as strategic as we can get with our customers. So it opens up new opportunities to sell, including software and other aspects of delivering value services, et cetera. So we're excited about it and we're looking forward to continuing to deliver through these vehicles.

Neil Dougherty:

Thank you, Adrienne.

Jason Kary:

Hey, thanks, Cole. And thanks everyone for joining us. I'm going to turn it over to Satish for a few closing comments and then we'll wrap up the call.

Jason Kary:

Thank you. Satish. And that concludes our comments today. Have a great day.

Operator:

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Second Quarter 2023 Earnings Conference Call. My name is Elisa, and I will be your lead operator today. [Operator Instructions] The call is being recorded today, Tuesday, May 16, 2023 at 1:30 p.m. Pacific Time. I would now like to hand the call over to Jason Kary, Vice President, Treasurer and Investor Relations. Please go ahead Mr. Kary.

Satish Dhanasekaran:

Thank you, Jason. Good afternoon, everyone and thank you for joining us today. Keysight delivered a solid second quarter performance caping of a record first half of the year. Our consistent execution as we navigate near-term macro dynamics reflects the resilience of our diversified business and the differentiation of Keysight solution portfolio. My comments today will focus on three key headlines. First, our strong financial performance in the second quarter demonstrated the depth and the breadth of Keysight solutions and operating discipline. Revenue was at the high-end of our guidance and earnings per share exceeded our guidance range as we delivered record gross margin and record free cash flow. Second, orders in the second quarter were stable and consistent with our expectations. As near term macro dynamics play out, we're capitalizing on growth opportunities across our end markets with particular strength in automotive and global aerospace defense. And third, we remain confident in the long-term secular growth trends in our markets. While the current environment is uncertain, we are continuing to prudently invest for the future to build on our leadership positions and to deliver on the long-term strategy that are laid out at our Investor Day in March. Now, let's take a deeper look at our second quarter results. Orders declined 10% or 8% on a core basis. Record Q2 revenue grew 3% or 5% on a core basis. Operational excellence combined with favorable software and services mix resulted in record gross margins of 67%, operating margin of 30%, record free cash flow of 370 million and earnings per share growth of 16%. Turning to our business segments. The Electronic Industrial Solutions Group delivered record Q2 orders, driven by demand in automotive and general electronics, representing 33% of the total company revenue, EISG revenue was an all-time high and grew 17% with strong double-digit growth across all end markets. This was also the eleventh consecutive quarter of double-digit revenue growth for this business segment, which underscores our broad market reach and diversified portfolio. In automotive, we delivered strong double-digit revenue growth and secure new strategic wins with two large OEMs. Building on our strong position in this market, we introduced further automation and protocol test capabilities for our industry leading EV charging test portfolio allowing customers to accelerate their innovation, improved battery performance, and ease of charging are among the most critical capabilities EV developers are bringing to consumers today. Keysight’s complete solutions allow customers to develop batteries with better range and faster charging time and importantly to efficiently test their interoperability against all global infrastructure standards under real world conditions. General Electronics revenue grew by double-digits to reach an all-time high. We are capitalizing on opportunities across a broad range of applications. For example, in quantum and silicon photonics where we are seeing more advanced research investment. In digital health, where we closed deals with several prominent medical device customers for Keysight’s microwave sensing and imaging solutions, and an industrial automation where customers are developing components and products to connect factory and warehouse environments. Our outperformance in general electronics in a soft demand environment demonstrates the benefit of the broad and diverse set of applications and used cases that we enable. Semiconductor solutions delivered double-digit revenue growth, driven by continued fab investments in new wafer capacity and advanced nodes. Our strong relationships with key customers in wafer test and precision lithography provide us with long range demand visibility, which remains favorable, despite near-term inventory headwinds. We believe the long-term growth drivers remain intact, supported by the government investments in initiatives such as CHIPS Act, and advanced node development for small, more efficient, and multifunctional chipsets. Turning to our Communication Solutions Group, revenue declined 3% against a strong compare of double-digit growth last year. At 45% of company revenue, Commercial Communications revenue declined 7%, which reflects the normalization of demand environment that we referenced last quarter. We saw cautious, but stable spending across the communications ecosystem, particularly in the smartphone and PC computing markets as customers work through post-pandemic, inventory dynamics, and macro uncertainty. At the same time, our customers continue to invest in long range strategic R&D programs. Keysight’s first-to-market solutions are enabling future requirements in 5G, including non-terrestrial networks, release 17 capabilities, Open RAN, AIML driven data center networks, and early 6G research. After a 3-year pause, we saw strong global industry participation at Mobile World Congress and Optical Fiber Conference this year. At these events, we showcased our capabilities with the key industry players to advance new technologies and used cases. This quarter, we enabled Samsung to demonstrate 5G new radio non-terrestrial network used cases and satellite connectivity. In addition, we secured a key win in commercial space to test antennas, transceivers, and telemetry systems. Keysight is also enabling ongoing Open RAN adoption. For example, CableLabs used Keysight's Open RAN architect solutions to achieve key interoperability milestones. Regionally, we saw strength in India with ongoing 5G and Open RAN deployments. Strategic data center R&D activity continues to gain momentum and Keysight secured an early win with a leading customer to implement AIML used cases. Our unique and comprehensive solution stack, which spans the physical protocol and the application layers, is enabling us to capitalize on these new market and technology inflections. We are also continuing to advance early 6G research with industry leaders around the world. In Japan, we engaged with NTT DOCOMO, a new spectrum technologies for sub-Terahertz frequencies. In the UK, in collaboration with National Physical Laboratory and University of Surrey, we enabled connectivity at speeds greater than 100 gigabits per second using Keysight’s 6G testbed. Turning to our aerospace and defense government business, we achieved record second quarter orders and revenue. Double-digit order growth was driven by increasing defense spending worldwide. At 22% of company revenue, ADG revenue was up 7%. Defense modernization spending remains strong in radar and spectrum operations, while investment in space and satellite and ongoing research in 5G and 6G drove growth. We saw strong demand from the U.S. and European primes with spend picking up in next generation programs. We recently announced software based real time spectrum analysis solution allowing satellite network operators to provide users with the highest quality of service. Keysight continues to innovate to meet the needs of this evolving market. Software and services revenue growth across business segments was steady and represented over one-third of company revenue. Value-added solutions are becoming increasingly important in the evolving design, emulation, and test environments. In collaboration with Synopsys and Ansys, we recently announced a 79 gigahertz millimeter wave radio frequency reference flow for TSMC. This allows us to provide mutual customers with the solutions they need to push the boundaries of RF and millimeter wave design into applications for autonomous systems. Technology megatrends and customers innovation workflows are driving an expansion in software opportunities. We expect software and services growth to continue to outpace overall company growth over the next three years. Before I turn it over to Neil, I'd like to highlight some of the things that make me proud to lead this company. A collaborative and innovative culture is one of the strategic enablers for Keysight’s continued value creation and an enduring competitive advantage. We recently published our 2022 corporate social responsibility report, which showcases the progress that we have made against our commitments and we're proud to have significantly surpassed many key impact goals for fiscal year 2022. We also released our 2022 diversity, equity, and inclusion report, which highlights the company's accomplishments in building an inclusive workplace and expanding new STEM partnerships. To sum it up, our market leadership and deep customer relationships are sustainable competitive advantages. We’re guided by our Keysight leadership model and run the company to outperform and to consistently create value under all business conditions. We believe the structural and financial flexibility of our operating model enables us to be resilient in the current macro environment. I would like to thank our employees for exemplifying a high performance winning culture and consistently delivering exceptional value to our customers and shareholders. With that, I will now turn it over to Neil to discuss our financial performance and outlook.

Jason Kary:

Thank you, Neil. Elisa, could you please give the instructions for the Q&A?

Samik Chatterjee:

Hi, thanks for taking my questions. I guess, if I start with the strong operating performance, I think, Neil, you were mentioning in your prepared remarks. Just maybe give us a bit more color there? Obviously, record gross margins, very strong operating margins in the context of sort of how the top line is playing out and how the macro is? What are the drivers behind the gross margin improvement? And overall, how much of this is just, sort of some of the supply pressures easing versus something that you, as you said, you've taken actions and sort of that's driving some of the improvement? If you can lay that out for us in terms of how sustainable that is? And I have a follow-up.

Satish Dhanasekaran:

This is Satish here. If I can add to Neil's points, quite pleased with the financial performance in this environment. Obviously, both CSG and EISG showed gross margin improvements. In EISG, a lot of it was linked to volume, but if you look, the business model is solid, right? You look at the software and services, have been steadily outpacing the business – overall business growth for a long time now, and we expect that trend to continue. And I would say that that gives us confidence, as Neil pointed out, that as we continue to execute our strategy of going up the stack all the way from physical protocol and application layers, we'll continue to have more opportunities moving forward.

Satish Dhanasekaran:

Yes. So, I think the headline on demand, I think, in orders has been stability, right? I think that's sort of the theme and it holds true even in Commercial Communications where, obviously, we discussed the dynamics of customers working through inventory corrections. Some of them are in a place where they're starting to think about next year's programs. They're starting to think about other programs. But then some of them are still working through the inventory correction situation in their business. So it's really dependent on different customers. But broadly, I would say, if you look at our 5G business, the R&D parts of the opportunity continues to hold up better, and there are different drivers there. And then you referenced the base station side, actually, was also holding up in-line with quarter one. And I think on the networking side, we had slightly down quarter-over-quarter. But all-in-all, it's holding up well at this time. I don't know that I would go as far as calling a trough or calling a bottom, but I – we remain focused on delivering to our customers' road maps. And we're seeing high engagement with our customers, particularly in comms after the OFC and Mobile World Congress, I think people are starting to think about what the future might bring, and there's tremendous opportunity to innovate and nobody wants to fall behind.

Samik Chatterjee:

Great. Thank you. Congrats on the execution.

Operator:

Thank you. Our next question comes from the line of Mehdi Hosseini with Susquehanna. Your line is now open.

Satish Dhanasekaran:

Yes. I think maybe from a business model standpoint, as you know, we've been driving to increasing solutions, more software and services mix, higher ARR, and that's been part of the strategy for go-to-market and that could alter in a very moderate way, the mix. But at some point, yes, I think as demand gets back in-line, we would expect the supply and demand balance to be restored.

Mehdi Hosseini:

Sure. Thank you. And I certainly don't want to take away anything from the demand drivers. And in that context, maybe you could remind us what are the key demand drivers looking forward, like 600 gig Ethernet [nearly] [ph] semiconductor? And to me, those dynamics are very different than the 5G investment cycle that you went through from 2017 through 2019. And then if you could just remind us how the next couple of years could be different than prior upturn?

Mehdi Hosseini:

Thank you.

Chris Snyder:

Thank you. So, fiscal Q2 revenue came in below typical seasonality. And obviously, you guys have been talking about the cyclical slowdown, so not a surprise there. But I guess my question is, if the guidance calls for, kind of typical seasonality into the third quarter with top line largely flattish, can we take that or should we take that as a vote of confidence that the market dynamics or demand is not getting worse?

Chris Snyder:

I appreciate that. And kind of taking that and following up on the guide. If my [back to] [ph] the envelope math is correct here, mid-single-digit EPS growth for the year would imply a pretty big decline in Q4, both versus Q3, but also year-on-year. And with top line seemingly at least, kind of stable, it would – it seems to be calling for a decline in margins. Any reason for that? I don't know if there's ever been a quarter where Q4 EPS came in below Q3. Thank you.

Satish Dhanasekaran:

Yes. And I think just to add to the point, right, it is an uncertain environment that's out there. And I think when we speak with customers, the engagement levels are high. But in terms of them planning for budgets, they're really relying on their underlying business to pick-up. And so there's that dynamic which results in an elongated cycle to close the pipeline, and so that's the case. And our guide, we try to be central weighted. We're not factoring in any macro recovery nor are we factoring in any recovery from China reopening into the guide. And those could be upside, but the macro could get worse too. So, that's the way we see it, and we'll keep you updated.

Operator:

Thank you. The next question comes from the line of Aaron Rakers from Wells Fargo. Your line is now open.

Satish Dhanasekaran:

Yes. Thank you. I think AI, it's safe to say that it's been under discussion for quite a long time, and you could say machine-learning algorithms are not that new. But what we're seeing now is a tick up in networks really thinking about the way to train AI models, the way to infer in an AI environment, and that creates some opportunities for us. I think Kailash has referred to that in our presentation at Investor Day as some pilots that we have going on. And fundamentally, you look at it at the high level, you have in a typical search not so traffic in the network. And with AI-ML, you have a lot of east-west traffic. And I think modeling that and being able to train your network to perform is going to become a differentiator. And I think having the full stack in wireless and [ wireline ] allows us to go address opportunities for our customers. How big that could be, I mean, to be determined. But I do know that a lot of our customers are having discussions with us at this time, and we're continuing to invest in this new emerging opportunity.

Neil Dougherty:

Yes. There have been no changes to our capital allocation priorities. Obviously, we re-laid them out at our Analyst Day in March. We continue to look for opportunities to grow our business via value-accretive M&A. While we didn't purchase any shares during the quarter for a variety of reasons, we've been very active in the buyback markets and would expect that our – to continue to be least anti-dilutive with our buyback programs and be opportunistic on top of that. And so, we continue to believe there is ample opportunity for us to create value through appropriate capital allocation.

Operator:

Thank you. The next question comes from the line of Mark Delaney with Goldman Sachs. Your line is now open.

Neil Dougherty:

Yes. As we said, the macro environment continues to remain highly uncertain, and we're not ready to make a call as to what the environment is going to be 6 months from now when we get to FY 2024. I think what we see right now is largely stability, and as Satish just said, we're not ready to call an upturn, but nor do we have any additional downside baked into what we're seeing currently.

Mark Wallace:

Sure, Will. This is Mark. I'll talk about the region trends. So, it begins with the word stability. We talked about that many times already. Q2 orders were steady and predictable and really consistent with our expectations. We saw increased customer demand and increased customer engagements with continuing focus on their R&D programs across all four regions. This was especially shown in the case for aerospace and defense, where we saw strong growth in demand across all of our regions. We saw the demand in automotive continue with some key wins, a couple of key OEM wins, particularly in Europe. And in general, the broad base of customers and the variety of applications that we serve within General Electronics really held up strongly across most regions as well. We did see some pullback, as we saw in Q1, around commercial comms that was centered with some of our larger customers in the Americas. We saw some pullback in short-term demand with semiconductor in Asia. But in general, across all regions, we saw this continuing stability in engagements and order flow as we expected.

Operator:

Thank you. Our next question comes from the line of Meta Marshall from Morgan Stanley. Your line is now open.

Satish Dhanasekaran:

Thank you. Meta, I'll take the second part first and then Neil will speak to the backlog. I think the – in comms, obviously, the big driver is new innovation, new technology trends. So, we saw strength in Release 17, non-terrestrial networks, all of the same themes that we've been talking about, and some increased investments around the globe around the next-generation technologies. And so, largely in R&D, the trends are holding. And in production environments, our production test environments is where we're seeing much more weakness in demand as customers are digesting this excess inventory associated with smartphones and PCs and such. And our share position, even though at a lower level, continues to be strong, and we're focused on our portfolio and our portfolio continues to grow, and we'll continue to release new products in alignment with customer needs. With regard to the backlog position, obviously, we have a backlog situation. As Neil mentioned, we have a growing deferred revenue balance with increasing focus we have placed on software services and ARR. And we also, in accordance with where we're seeing the order strength, whether it's automotive or in semiconductor or in aerospace defense, we're also providing more system type of capabilities to our customers, which have longer lead times. Neil will give you more specifics.

Meta Marshall :

Okay. Perfect. Thank you.

Adam Thalhimer:

Hey guys. Nice quarter. Neil, the working capital was pretty negative in 2022, and it looks like it’s, kind of finally starting to swing positive in Q2. Do you expect that trend to continue in the back half cash from working capital?

Adam Thalhimer:

Okay. And it was slight, but the CapEx guidance came down a touch. Just wondering what drove that?

Adam Thalhimer:

Thank you.

Matt Niknam:

Hey guys. Thanks for taking the question. Congrats on the quarter. I want to go back to gross margins, and maybe if we can talk a little bit about some of the drivers of upside. I think there was reference to product mix, if we can just go back to that and unpack that. And I'm also curious whether there were any software license sales in there that may not recur on a go-forward basis? And then just one follow-up as well on orders, if you could talk about the linearity over the course of the quarter and how that trended by month, if possible? Thanks.

Mark Wallace:

Yes. And Matt, as far as the order flow within the quarter, I would say it was very typical for a Q2 as the second period and the 6-month performance period, we saw it ramp throughout each of the 3 months. February is a shorter month, fewer selling days. As you get to the end of the performance period with our incentive comp and sales, we do expect a stronger finish, which is exactly what we saw. What I can say though was very consistent was the, kind of elevated level of customer engagement as customers prioritized on different programs that they felt were important going forward, and we saw that really is a stabilizing factor after coming out of Q1. So, we did see a ramp, but I wouldn't read anything more into that other than the natural seasonality of the Q2.

Neil Dougherty:

No.

Operator:

Thank you. The next question comes from the line of David Ridley-Lane with Bank of America. Your line is now open.

Satish Dhanasekaran:

Yes. I think as we mentioned, automotive has been a fairly new vertical expansion for us, one that we focused on since Keysight was formed, and we have successfully grown that to over $500 million. And we continue to see even more opportunity to expand as there's going to be ongoing innovations in EV and AV, not only in automobiles, but in other sectors as well, with the push for autonomous and electrification even in a broader set of industries. And we're continuing to build the most comprehensive portfolio all the way from design to silicon bring up to simulation, validation, compliance testing and manufacturing with more emphasis on R&D, really. And we're helping create standards, we're also working on finding new methodologies for testing that will be disruptive. And to that extent, we've made a small technology tuck-ins that have enhanced our software content and ability to make contributions to the workflow in this area. And we see, as we think about our M&A, we see a strong pipeline for opportunities and we'll continue to evaluate them against our strategic and financial hurdles, and we'll look to lean in for the right opportunity.

Neil Dougherty:

Yes. So still improving. For a significant part of the portfolio, we're already back. There's another significant chunk that should work its way back to kind of pre-COVID lead times here over the third quarter. And then there will continue to be some outliers beyond that, but we're rapidly moving in the right direction.

Neil Dougherty:

Thank you.

Jason Kary:

Thanks Elisa, and thanks everyone, for joining us today. That concludes our call, and we look forward to seeing you at some of the upcoming conferences here in the quarter.

Operator:

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal First Quarter 2023 Earnings Conference Call. My name is Jason, and I’ll be your lead operator today. After the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded today, Tuesday, February 21, 2023 at 1:30 p.m. Pacific Time. I would now like to hand the conference over to our host, Jason Kary, Vice President, Treasurer and Investor Relations. Please go ahead.

Satish Dhanasekaran:

Thank you, Jason. Good afternoon, everyone and thank you for joining us today. Keysight delivered exceptional first quarter financial results, posting revenue and earnings above the high end of our guidance against a backdrop of moderating demand. Our performance and consistent execution demonstrate the resilience of our business, and despite the challenging macro dynamics, we believe Keysight is well-positioned to build on our success and expand our leadership across our end-markets. I’ll focus my comments today on three key headlines. First, we achieved strong financial results. Revenue was a first quarter record and grew 14% on a core basis, driven by strength in both business segments and across all geographies. We again demonstrated the durability of our financial model and delivered $2.02 in earnings per share. Second, we started to see a normalization of what has been a robust and prolonged period of investment by our customers. Over the past two years, significant demand for Keysight’s solutions resulted in a 15% compound order growth rate and a book-to-bill of 1.09. As demand slows in the near-term, Keysight’s exposure to multiple end markets, its differentiated portfolio, and our strong operating discipline positions us well to weather the current macro dynamics. Third, we remain confident in the secular, long-term growth trends across our markets. Our software-centric solutions strategy is well-aligned with the needs of our customers, which we expect will enable us to outperform the market. We look forward to providing you a more comprehensive update on our long-term growth strategies and financial objectives at our upcoming Investor Day. Now let’s take a deeper look at our first quarter results. Orders declined 13% year-over-year against a strong compare of 22% growth in the last year’s first quarter. The slowing demand and business specific headwinds that we anticipated last quarter materialized largely as expected. These included the year-over-year impact of currency, our exit of Russia, and incremental China trade sanctions, which together contributed to a 6-point drag on the compare. We saw customers exercise caution in response to macroeconomic uncertainty. This was most notable among our largest customers in Commercial Communications, who were impacted by sharp demand decline in consumer electronics and computing segments. They are restructuring and reassessing their near-term priorities as the industry digests inventory, while at the same time maintaining investments across key, strategic programs. While the duration is difficult to predict, we expect these dynamics to weigh on our customers for at least the next couple of quarters. Despite macro challenges, revenue grew 10%, or 14% on a core basis. Strong execution and operational discipline resulted in gross margin of 65%, operating margin of 30%, and earnings per share growth of 22%. Turning to our business segments. The Electronics Industrial Solutions Group revenue grew 19% and delivered double-digit revenue growth for the 10th consecutive quarter, which underscores the diversity of our industry exposure. In automotive, we achieved record revenue and strong double-digit growth across all regions. Sales of electric vehicles continued to grow significantly in 2022, further fueling investment in EV and AV technologies and manufacturing. This quarter we secured multiple strategic wins with large OEMS and Tier 1 suppliers across a breadth of applications such as 5G, autonomous driving emulation, battery and charging infrastructure design, and in-vehicle networks. To strengthen our position in this market and capitalize on this growing, decades-long opportunity, we continue to expand our portfolio of solutions. An example is our current collaboration with Jiyun Technologies to develop a high-efficiency, compact battery test system to help accelerate the launch of new electric vehicles. In general electronics, double-digit revenue growth was driven by continued strength in emerging verticals such as digital health and IoT. We also secured wins in advanced research, as R&D investment remains robust in quantum, photonics, and Beyond 5G. Semiconductor solutions revenue growth was driven by continued fab investments in new wafer capacity and advanced nodes. While the inventory adjustments are pacing demand, foundries continue to execute their longer-term plans to globalize their production. We see significant opportunities in this market, and are investing in solutions for emerging semiconductor applications such as silicon photonics, high-power semis, and millimeter wave. Turning to our Communications Solutions Group, revenue grew 7%, with growth across both end markets and all regions. Commercial Communications revenue grew 11% on a core basis, to reach a record Q1, which was driven by ongoing, strategic investments in communications ecosystem. We saw strength in 5G R&D and deployments, Open-RAN, and datacenter networking, with increased focus on 800 gigabit and terabit communications solutions. These programs remain a priority and are driving demand for Keysight’s first-to-market solutions. As a trusted advisor, we remain actively engaged with our customers as they adapt to the current macro environment. We recently announced our collaboration with Qualcomm to accelerate 5G non-terrestrial network communications for broadband in remote areas, and enable device makers to speed development and verification of 3GPP Release 17 compliant designs. We continued to support the progression of standards and submitted the first 3GPP Release 16 protocol conformance test, enabling new use cases such as private and industrial networks, and autonomous vehicles. Investment in early 6G research is underway and Keysight joined forces with 16 organizations to create 6G-SANDBOX, a pan-European testbed for 6G experimentation and validation of 5G-Advanced and 6G capabilities. Nokia recently selected Keysight’s sub-Terahertz testbed to validate D band and E band technology to accelerate R&D critical to 5G-Advanced and 6G use cases in millimeter wave and sub-terahertz frequency spectrum. We also announced industry’s first and highest density network cybersecurity test platform, which provides data center network infrastructure and cloud providers with leading 400 gigabit Ethernet security validation capabilities. These solutions reinforce our leadership across wireless and wireline ecosystems. We are also looking forward to Mobile World Congress in Barcelona next week. Keysight will be engaged with many customers and industry leaders, and showcasing our solutions for advancing 5G standards including Release 17 and early research in 6G and intelligent automation. Turning to our government, defense, and aerospace business, record Q1 revenue grew 9% on a core basis, achieving its second highest revenue quarter driven by increased U.S. government spending, and strength in space and satellite, including new applications for non-terrestrial networks. We recently won a five-year contract with the U.S. Army who chose Keysight’s Field Fox handheld spectrum analyzer for field use. We expect U.S. government budget appropriations to ramp spending in new programs in the second half of this year. We also anticipate an increase in defense budgets worldwide, and growing investment in new technologies such as 5G, space and satellite, quantum, and advanced research. Consistent with our strategy, we continue to expand our software capabilities. We recently completed the acquisition of Cliosoft, whose data and IP management software tools enhance our portfolio of electronic design automation solutions. In addition, Eggplant’s test automation platform was recently recognized as a leader by The Forrester Wave. About one-third of total revenue, the growing mix of software and services is integral to the durability of our financial model. Keysight’s differentiation is a function of our software-centric solutions strategy, collaboration with our customers, and investments we are making to ensure that we address the most challenging technology needs of today, and into the future. We are prioritizing high-conviction growth opportunities to solidify our competitive position for the long-term, while at the same time accelerating initiatives to drive further efficiencies consistent with our financial model. We remain committed to creating long-term value for business stakeholders, and positively impacting the global community. I’m proud that Keysight has been named to the Dow Jones Sustainability Index for the fourth year in a row. I’d like to thank all our Keysight employees for their dedication and relentless execution, which drives our strong track record of performance and is a testament to Keysight’s Leadership Model, our values, and to our people. With that, I’ll now turn the call over to Neil to discuss our financial performance and outlook.

Jason Kary:

Thanks, Neil. Jason, can you give the instructions for the Q&A, please?

Mark Delaney:

Yes. Good afternoon. Thank you very much for taking the question. I was hoping, first, if you could elaborate a little bit more on the comments on orders. It seems like it’s particularly impacting the Commercial Communications business and maybe certain other areas are doing a bit better. But if you could offer a bit more on where you’re seeing the orders and where perhaps you’re seeing some moderation from customers?

Mark Delaney:

Thanks, Satish. That’s very helpful. My other question was on the cost controls, and the Company spoke about being disciplined. Were you alluding more to the variable nature of your cost structure, and that will moderate spending depending on what demand ultimately does this year, or are there more specific steps that Keysight is planning to take on cost controls? Thank you.

Operator:

Our next question comes from Mehdi Hosseini with SIG.

Satish Dhanasekaran:

Yes. Maybe I’ll just start, and then Neil can add. I’d say that if we look at our end markets and if you take a look at the commercial comps, especially in the wireless side, the top customer pull back is definitely macro related and related to the inventory exposure that they have, which has been widely talked about. But if we look at the base customer spend, it remains pretty strong. So, that’s as far as that end market is concerned, but we start to look at aerospace defense and our industrial exposure, which continues to provide us top line diversity. And I think that will play out as we go through the year as well. Neil, specific to our backlog position?

Mehdi Hosseini:

Sure. And just a follow-up here. You did $1.3 billion of new orders. Is there any way we could think about the R&D portion of that order or the strategic investment that were reflected in the $1.3 billion from production? And I’m just trying to better understand how we should think about the downside risk in booking activity from here? Is there like a -- is $800 million a quarter the worst-case scenario, or anything in that nature that you can offer would be very helpful.

Mark Wallace:

Yes. And I would -- Mehdi, I would -- just to directly answer your question, the mix during the quarter was still very predominant R&D. And Satish mentioned, the pullback was much less there and especially in commercial comms than it was on the manufacturing side. The other factor that we’ve talked about in the past on other conference calls is our funnel. We have a six-month funnel that gives us a strong indication of the forward-looking demand. That has been factored into our guide. It has normalized with the effects that we saw pretty acutely here in the first quarter. And looking out six months, the demand signal looks to be fairly consistent, in line with what we saw in Q1.

Operator:

Our next question is from Meta Marshall with Morgan Stanley.

Satish Dhanasekaran:

Yes. Meta, thank you. So first of all, we remain intensely focused on continuing to innovate and strengthen our portfolio. So from an R&D perspective, the collaborations we have with our customers informs where we invest, and we feel pretty good about it. At best, some of these pullbacks are short-term delays for R&D spend, and we expect those to recover as our customer deals with these inventory dynamics that we mentioned. With regard to 5G, I think I would say that the R&D roadmap remains in place, right? Our customers have a multiyear roadmap, and they continue to invest to realize that roadmap. And at the big picture level, I would say while substantial progress has been made in terms of 5G deployments, we still have about roughly 1 billion subscribers in the world, and the roadmap is to take it from $1 billion to $5 billion in the next five years or so. So clearly, there’s more deployment activity occurring that’s in front of us with India and other parts of the world leading that effort. The standards progression, which really is a basis for R&D business with Release 16 and Release 17, moving into Release 18, which will be 5G advanced, is pretty strong. And those innovation vectors around non-terrestrial networks, new features such as RedCap for IoT applications -- proliferation of 5G into new verticals remains areas of opportunity for us that we’re investing in to continue to differentiate along with Open-RAN as well, which we have talked about. But the industry roadmap remains solid, and our differentiation remains strong in these markets.

Operator:

Our next question comes from Samik Chatterjee with JP Morgan.

Mark Wallace:

Sure. Samik, this is Mark. I’ll take the first question on linearity of orders. And it was -- we had about two-thirds of our orders after the second month. We had a big finish to the end of FY22 and our fourth quarter. So, we had a nice rebound in December and the last quarter was about 34% of the total orders of bookings for the quarter. So, it was a pretty linear flow of business. On the electronic industrial side, what we see, as Satish mentioned, is continued demand around next-generation process technologies for our semiconductor business, very long-term secular growth drivers that we’ve been talking about for a long time. The activity level and focus around the next-generation auto, EV in particular, is continuing to ramp. Again, this is a decade-long transformation. The number of EVs sold last year as opposed to ICE vehicles continues to grow. So, I see this as a long-term trend. And what I was particularly surprised with was how our general electronics business held up, particularly around some of the verticals that we’re focused on, digital health care, advanced research and education. Obviously, some of this is exposed to broader GDP kind of markets, and we saw the PMI stay below 54. I think it was five or six months in a row. But in general, the three segments below EISG continued to show resilience and, overall, continued investments in these next-generation technologies.

Satish Dhanasekaran:

Yes. Thank you, Samik. I’d say you’re right. We don’t comment on any specific opportunity. I would just say that we remain confident in the business that we run, its cash generation potential. You’ve seen the strong free cash flow performance of the business. And so congruent with that, we have a consistent capital allocation discipline, which is around organic growth and M&A where it makes sense and return of capital. And with regard to M&A, you’ve seen us be incredibly patient and disciplined with regard to the opportunities we pursue. We look at hundreds of companies after having done market assessments on them. And then we’ve done about 20 to date. And we’ve been -- and we’ve done them with a view of the strategy and what scale that we can bring to the target and how we see the -- first, the strategic fed, but second and equally important is the return to our shareholders. So, I think those hurdles will continue to remain in place, and we remain very disciplined.

Christ Snyder:

So back on the conference call in November, the Company talked about book-to-bills approaching a more normalized 1.0x. The quarter came in a bit below that at 0.94. So, were orders in the quarter softer than you would have expected back in November? Or [Technical Difficulty] for book-to-bills to improve as the year goes on and kind of reach that more normalized average of 1.0x for the full year?

Christ Snyder:

Thank you. I appreciate that. And then just kind of staying on orders for fiscal Q1, is there anything or color you could provide around how orders in China did during the quarter, given a lot of the disruption over there? And also government and defense business orders, just given some of the budgeting resolution processes going on? Thank you.

Satish Dhanasekaran:

Yes. Just maybe to add a comment to Mark, the space and satellite also continues to inflect for us in the aerospace defense business, and is showing some momentum there with customers, too.

Aaron Rakers:

I’m going to go back to kind of the order and backlog dynamics. Neil, I think last quarter, you had mentioned that you were maybe about four or five weeks of kind of inflated or elevated backlog relative to normal. I’m curious where that stands right now? And does your low single-digit assumption assume -- growth-wise assume kind of back to normalized backlog levels through the course of the year?

Aaron Rakers:

Okay. And that’s helpful. And then, a quick follow-up. Just on the semiconductor business, you continue to perform well. And I don’t know the answer to this question, but I’ll just put it out there, is that -- is there any kind of disruptions? I think there’s been a supplier in the semiconductor supply chain that had seen, I think, some cyber attack issues. Is that at all impactful to your business or not?

Operator:

Our next question comes from Jim Suva with Citigroup.

Neil Dougherty:

Yes. So what I said, first of all, we weren’t guiding the year. What we said is, it’s a highly uncertain environment, it’s difficult to know. But if the demand stays consistent with where -- what we saw in Q1 through the remainder of our year, we would expect to deliver in that scenario low single-digit revenue and low single-digit EPS growth. Obviously, our model calls for higher revenue growth than that with 40% operating leverage, which enables us to get to double-digit EPS growth. So, in a scenario where revenues are growing at a lower level, coupled with this inflationary environment, which is a bit abnormal, we’d be looking at low singles for both revenue and EPS. Again, under that specific scenario where our orders remain more or less in line with what we saw in the first quarter.

Neil Dougherty:

So, the new China trade restrictions that came about in December is an additional 1 to 2 points of headwind for us over the longer term. The comment about 6 to 7 was -- on the call last quarter, I outlined what at the time we thought was going to be 8 points of headwind coming from China, Russia and FX. As we got to the end of the quarter, what we thought was going to be 8 was more like 6.5, so call it 6 to 7, and that’s largely because the dollar backed up a little bit. So, the FX impact was less than originally expected. The China impact was slightly less as well.

Matthew Niknam:

Maybe just a follow-up on that last one. On the Analyst Day, I’m just wondering any initial thoughts on what we could expect on March 7th in terms of just updates to longer-term targets? And then just on the M&A backdrop, I’m just wondering, what’s the latest you’re seeing in terms of opportunities and valuations. And I know in the past you’ve been focused on some smaller size software deals. I’m just wondering if that’s still the focus or maybe whether you’re open to larger deals, just considering the pullback in private market valuations. Thanks.

Operator:

Our next question is from Adam Thalhimer with Thompson Davis.

Neil Dougherty:

Yes. We’ve had no increase in our cancellation rate. So we continue to believe the quality of our backlog is very high.

Satish Dhanasekaran:

Yes. I think I’ll take this. Satish here. Every recession, the environment is different. And I would say that after having a couple of very strong growth years, some normalization was inevitable. And what we’re seeing is pull back from some of the customers in response to some of the inventory excesses in specific markets. But I go back to our portfolio position is the strongest it’s ever been because of our emphasis on solutions. Our business model today is much stronger because we have -- over 33% of our business is software and services, which gives us additional resilience. And we have a strong operating model at the Company that allows us to tide over some perturbations in the marketplace. And we also enter the year with a strong backlog position as well. So from those perspectives, it’s different. I also think if you look at the gross margin at the Company level, we continue to stay strong at 65%. And I think with the operational model in place, we remain confident about our ability to demonstrate that resilience.

Rob Mason:

Satish, frankly, I’ll follow up your comment with a question just around the software orders in the quarter. I kind of inferred that they remain resilient. But as you think about where you’ve seen some challenges in Commercial Communications, to the extent that there’s a slowdown in renewals, or is that something that hits your radar screen as you see some of the headcount reductions take place in the tech sector? Just how you defend against that?

Mark Wallace:

Yes. Rob, just to answer -- yes, that was -- Satish did a great job. And I’ll just let you know we didn’t see the pullback in software like we did in other parts of the business. As a matter of fact, our renewals were up and our growth from subscriptions and enterprise agreements remained steady, which is what you would expect from a sticky business, something that has kind of a continuous flow of value in a subscription model. So that really worked for us this quarter.

Neil Dougherty:

Could you repeat that? I’m sorry.

Neil Dougherty:

Yes. I mean I don’t think you can draw any conclusions looking at historical sequential gross margin data as to what to expect. At least as I would think about it, any perturbations that may have appeared to have repeated have to be more coincidental than systematic.

David Ridley-Lane:

The typical seasonality is for a nice sequential uptick in EISG in the second quarter. Lot of the commentary on the call has been that ESG remains pretty strong. I mean, within your second quarter guidance, should we expect kind of that historical sequential pattern in EISG?

David Ridley-Lane:

Got it. And then also IE -- on EISG, excuse me. The trend in gross margin has been a little bit softer over the last couple of quarters. Is there -- that being said, margin expansion -- operating margin expansion has continued to be quite good. But I’m just wondering, is there something in the mix or other dynamics that you could call out to sort of explain that gross margin trend there?

Operator:

There are no more questions, so I’ll pass the call back over to the management team for closing remarks.

Operator:

That concludes the conference call. Thank you for your participation. You may now disconnect your lines.

Operator:

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Fourth Quarter 2022 Earnings Conference Call. My name is Dante, and I will be your lead operator today. After the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded today, Thursday, November 17, 2022, at 2:00 PM Pacific Time. I would now like to hand the conference over to Jason Kary, Vice President, Treasurer and Investor Relations. Please go ahead, Mr. Kary.

Satish Dhanasekaran:

Thank you, Jason, and thank you all for joining us. Keysight reported strong fourth quarter results, which exceeded the high end of our guidance and drove a strong finish to the year. Before we get into the quarter, I want to highlight our exceptional performance for fiscal year, which illustrates continued progress we're making in transforming the Company to a software-centric solutions provider. We set new records for orders, which grew 12% to $6 billion, a new record for revenue, which was up 10%, and a new record for earnings per share, which increased 22%, all the while returning capital through $849 million in share repurchases or 89% of free cash flow. In addition, we continue to invest in next-generation technologies for long-term differentiation and see a high level of engagement and activity with our customers around their future needs. Today, I'll focus my comments on three key headlines. First, we delivered an all-time record revenue and earnings per share in the fourth quarter ahead of expectations enabled by outstanding execution by Keysight teams who successfully navigated supply chain, geopolitical and macro dynamics. Second, we achieved record orders of $1.6 billion with steady bookings throughout the quarter and a book-to-bill of 1.09. While our customers' multiyear road maps remain unchanged, they are exercising more caution given the macro backdrop, which we anticipate will moderate demand in the near term. Third, as we enter fiscal '23, we remain confident in our ability to outperform the market based on the differentiation of our solutions, our strong R&D customer value proposition and the robust backlog position we have entering the year. And as we look longer term, the secular innovation trends in our end markets remain strong. Now let's take a deeper look at the strength of the fourth quarter. Record orders of $1.6 billion grew 9% on a core basis. Record revenue grew 15% on a core basis, with solid growth across all regions as Keysight team successfully navigated challenging dynamics. This resulted in record quarterly earnings of $2.14 per share. The strength and resiliency of our business model is due to our strategic efforts to diversify our industry exposure. This has been best exemplified in the growth of our Electronic Industrial Solutions Group and our ability to leverage our industry-leading first-to-market solutions to enable expansion across the broader communications ecosystem. EISG achieved its ninth consecutive quarter of double-digit order and revenue growth. Auto, semiconductor solutions and general electronics all achieved record quarterly revenue. For the year, both orders and revenues set new records as we capitalize on continued investments across all three EISG markets. In automotive, we're pleased with the continued adoption of our solutions portfolio as orders grew double digits for the seventh consecutive quarter and exceeded $500 million this year. Automotive OEMs and their suppliers continue to focus on strategic new mobility investments, which drove key wins for Keysight. In addition, automotive-focused semiconductor companies continue to add capabilities to support EV and AV applications, which we view as a favorable long-term dynamic. We recently announced the Scienlab DC Emulator, which enables customers to accurately characterize high-voltage, high-power electric vehicle battery performance under varying real-world charging conditions. And Keysight's PathWave Lab's operation software won 2022 AutoTech Breakthrough Award for overall electric vehicle technology. In support of AV applications, silicon designers are exploring adoption of commercial standards such as MIPI for automotive and other surround sensor applications, including cameras and in-vehicle infotainment displays. We are now expanding our leading compliance test solutions to offer advanced verification and diagnostic capabilities for automotive designers. Turning to our semiconductor solutions business. Q4 was the tenth consecutive quarter of double-digit order book and a record revenue quarter. We saw sustained demand for our wafer test solutions and precision positioning capabilities, which enable the realization of advanced process nodes. In addition, Keysight has continued to partner with industry leaders, Synopsys and Ansys, on RF and millimeter wave integrated circuit design flows built for today's wireless communication requirements, including 5G and 6G system-on-chips. Keysight received a Partner of the Year Award from TSMC for joint development design flows in RF and millimeter wave nodes. In general electronics, record orders grew double digits this quarter as demand remains strong and broad-based across industrial IoT and digital health as well as education and advanced research markets. Turning to Communication Solutions Group. The business delivered strong orders and record revenue. Annual orders and revenue were all-time highs despite geopolitical headwinds and delays in U.S. Defense budget appropriations. Commercial communications revenue grew 10% and 11% for the year, with growth across all regions. Investments across communications ecosystem continued throughout the year with sustained spending in next-generation wireless and wireline technologies. Ongoing investments in 5G standards, new spectrum growing deployments around the world and steady evolution from 400 gig to 800 gig to terabit Ethernet drove growth. We ended a record year for 5G orders as Keysight's market-leading solutions continue to provide industry with new capabilities needed for development of next-generation devices as well as wireless and wireline networks. Examples that highlight our portfolio's alignment with key industry priority include a recent partnership with IBM to integrate our Open RAN capabilities into their cloud automation tools to accelerate network deployments. We also completed the validation of our first 5G location-based service use case from Global Certification Forum by combining the testing of 5G new radio and global navigation satellite system technologies into a single platform. Lastly, in collaboration with key silicon and data center partners, we enabled the industry's first 1.6 terabit transmission and data center interconnect, leveraging our high-speed digital solutions. Aerospace, defense and government business revenue grew 4% for the quarter and 3% for the year, setting a new record while navigating geopolitical headwinds. Steady investments in spectrum operations, cybersecurity and space and satellite drove demand. 5G continued to expand in aerospace and defense end markets, and we saw increasing investment in advanced research. Proposed increases in investment in the U.S. and allied countries for modernization of defense capabilities and new satellite and space applications position us well for future opportunities. As an integral part of our solution strategy, software and services order and revenue growth this year continued to outpace Keysight overall, which has driven our annual recurring revenue to approximately $1.2 billion. Software and services again represented just over 1/3 of Keysight's total revenue for the year. Keysight's focus on customer success and innovation is driving our development of first-to-market, high-value solutions. Our achievements over the years exemplify Keysight's collaborative culture and our talented workforce, and we are honored that Keysight has placed tenth on the Fortune's Best Workplaces in Technology list for 2022. We believe our differentiated culture gives us a unique ability to recruit and develop capable talent and will be our sustaining competitive advantage. In conclusion, I would like to thank our employees for all their contributions, commitment and strong track record of execution. In the midst of an uncertain economic environment, we remain confident in the resilience of our business, the strength of our balance sheet and the flexibility of our operating model. Now, I'll turn it over to Neil to discuss our financial performance and outlook in more detail.

Jason Kary:

Thank you, Neil. That concludes our formal remarks. Dante, could you please give the instructions for the Q&A?

Angela Zhang:

This is Angela Zhang on for Samik Chatterjee. Congrats on the strong quarter and outlook. My first question is sort of related to what you mentioned briefly in the prepared remarks on sort of macro slowdown and perhaps some pullbacks. I'd like to dig in a little more there. Given that we've seen commentary from other companies indicating that there's a pullback in telco CapEx, are you seeing any impact on their R&D budget? And then I have a follow-up.

Angela Zhang:

Great. And then just for my follow-up, you posted 10% revenue growth this year. And I know your long-term guide is sort of mid-single-digit revenue growth. Just what are you thinking sort of broad strokes for fiscal '23 revenue growth where you -- did you see a pull forward with supply easing? And so could there be an air pocket in fiscal '23? Or do you still expect to sort of perhaps trend above your typical long-term range?

Operator:

Our next question comes from the line of Chris Snyder with UBS. Your line is now open.

Mark Wallace:

Chris, this is Mark. I'll take that and add a little bit more detail here. So as Satish said, our order level was steady throughout the quarter. So, we're watching this, right, because if customers are taking more time to make decisions, you would look for orders to slow down. They did not. As a matter of fact, October was very strong. It was a record October for us in terms of orders. So that's good. You've heard us talk about before the addition of new customers. We've added about 450 this quarter again for nearly 2,000 new customers across the whole year. So that creates more diversity and durability to our business, and I see that paying off. Our top 20 customers in the quarter were up strong double digits as well. So, all of that continues to translate to the fact that we did not see an impact to our business because of the customers taking more time. And I think it also has to do with the fact that we are so biased toward R&D and design optimization. And as we've seen through other waves in the recent term where market slowed, the advanced technology development continues. So that's what we see, but we look around and we do see some macro uncertainty. And from my seat, what I see in terms of order or in terms of customer activities is very active customers. Our six-month funnel continues to grow, but customers are taking more time to make ultimate CapEx decisions.

Chris Snyder:

Appreciate that. And on the commentary that customers are taking longer to order, maybe they're ordering slower, how do you separate kind of the supply chain element of that from the demand element? Because if supply chains are generally moving in the right direction, I think that maybe customers will not kind of order with the same lead times or urgency that we saw last year.

Neil Dougherty:

Yes. I guess the only other point that we make around that level is, if you look at our last three years, we've averaged a book-to-bill over the last three years of 1.09 driven first by COVID, obviously, then by the supply chain disruption that's happened over the last, say, 18 months. And so we've known for some time that, that book-to-bill had to normalize. And as our lead times come in, we would expect that normalization to occur. And so, as I think about it -- and again, we're not guiding orders, but a move of our book-to-bill back to a more normal level, something approaching one is not something that's going to impact our ability to continue to grow revenue.

Mehdi Hosseini:

Two follow-ups. I want to go back to CapEx to 250. Should I assume that capital intensity will remain around 3% in fiscal year '23?

Mehdi Hosseini:

So, I shouldn't use your CapEx guide to come up with some revenue guide or revenue growth expectation for fiscal '23? There is some cash flow as per the CapEx, right?

Mehdi Hosseini:

Okay. And then, I want to go back to China. The APAC region as a percentage of revenue has remained in the low 40% over the past several years, including the headwind from Huawei. Should I assume that you're growing outside of China so much should extend that you're able to offset increased restriction on shipment to China? Is it just a mix within the APAC region that makes China kind of neutralized?

Mehdi Hosseini:

Okay. So the fact that the supply chain is moving out sort of China, that's positive. Now if I may, just a quick follow-up. So you do have more than 50% exposure to your customers' R&D budget. On top of that, there is a structural changes happening with the supply chain that is also positive. And those two factors on aggregate could offset some of the cyclicality nature or production-related sensibility or volatility. Is that the right way to think about this?

Operator:

Our next line of questions comes from the line of Matthew Niknam with Deutsche Bank. Your line is now open.

Neil Dougherty:

Yes. So this is Neil. I'll take the backlog question and then let Mark address the China question. But yes, so you're -- I mean, obviously, our orders within the quarter outpaced revenue by a little bit more than $100 million. So we do continue to add to the backlog as we've gone throughout the year.

Operator:

Our next line of questions comes from the line of Aaron Rakers with Wells Fargo. Your line is now open.

Satish Dhanasekaran:

Yes. Thank you for the question. I think at the highest level, we're at approximately 60% R&D today, 30% manufacturing and 10% deployments. So that's the sort of mix of the business. Clearly, we believe R&D secular, you look at some of the areas in R&D that we're focused on, that involve next-generation innovations such as with 5G and then 6G and automotive and digital health, so on and so forth. And it really gives us this diversity of applications that is -- gives us a resilience in this environment for sure. With regard to the software strategy, it, again, goes congruent with our with our go-to-market approach because we're here to enable innovations to happen faster. And the way we do that is by offering more software-centric solutions. So as we deploy more solutions to our customers, increasingly, that is in the form of growing software mix. And that goes, again, synergistic with our services strategy. So you look at our software and services revenue this year will end at 3% of the total mix and our ARR, or annual recurring revenue, has reached a new high of $1.2 billion. And we'll continue to invest to grow those portions of the business and increase our resilience and durability over time as well.

Neil Dougherty:

Yes. I mean given some of the dynamics that Satish just talked about, increasing software services, recurring revenue, we have seen growth in our deferred revenue over the same three-year period of time as well as our migration towards systems rather than tools, I think, will drive our ultimate backlog level when things normalize to be significantly higher than it was, say, pre-COVID in the 2018, 2019 time frame. And so I think we'll have to see how that plays out over time. I think again, we built -- you can do the math. We built well north of $1 billion of backlog over the course of the last three years as we've had this book-to-bill that I've mentioned of 1.09. And as our lead times come in, we're going to expect ordering patterns to adjust and lead times to pull in. I've said previously that there's probably four to five weeks' worth of kind of abnormal backlog as a result of a four- to five-week extension of lead times kind of on average would be a way to think about it.

Operator:

Our next line of questions comes from the line of Jim Suva with Citi. Your line is now open.

Satish Dhanasekaran:

Yes. Jim, I think as a strategy, as a company from -- in 2015, we've been focused on the software-centric solution strategy and really focused on our customers' most demanding and challenging problems that they have and solving this better than anyone else. And as we have continued to do that, our strategy has taken the form of not just prudency in sales, but our focus on this life cycle value creation for our customers, but also value capture for Keysight. And that's the journey we've been on. Some of the more newer solutions such as in Open RAN that we've talked about where we are seeing considerable traction, software alone is nearing 40%, 50% of the total sale value, and with a lot bigger portion of it being in the recurring category as well. So, we feel good about the continued traction we're seeing for our solutions. And so we continue to deploy the solution strategy over time, we will enter into new end market verticals. And as you've seen some examples I put out this latest earnings announcement, we've also had some successes in the automotive sector with deploying software and in the semiconductor as well with our design offerings. Mark may make some comments on the sales side.

Jim Suva:

Great. And then my follow-up is on the China. I think I heard two to three points of headwind. Is that for kind of the full fiscal year? Was there any, like, in calendar -- I'm sorry, fiscal Q4, like buying ahead of the rule changes? I'm just trying to kind of triangulate around the magnitude of it. And I assume after fiscal '23, it's kind of all out of the model from the rule changes.

Operator:

Our next line of questions comes from the line of Meta Marshall with Morgan Stanley. Your line is now open.

Satish Dhanasekaran:

Yes. Thank you, Meta. I think on the 5G front, I think as we have always stated, there are multiple catalysts. I think about 18 months ago, I said the first catalyst was the C-band deployments in the U.S. That's played out as we had hoped, and we have captured a lot of that spend. We are pleased with some action that's happening in Asia and India, parts of India that have made commitments to roll out 5G. So that's, again, opportunity for us that's playing out right now. But the second and the third part to this is the millimeter wave opportunity. There's still some complex challenges with millimeter wave that customers are trying to solve. That continues to be a longer-term R&D opportunity for us as that deployment has continued to push out anyway -- scale deployments anyway. And lastly, as 5G is deployed, operators are looking to further monetize by adding the SA versions and new applications such as Open RAN continue to be gain traction across the global ecosystem. And so, the opportunity that we have in R&D continues to grow, and we're well positioned with the comprehensive offerings we have to address it. I also want to point out that we have a very diversified business. Yes, 5G gets a lot of attention, but we have secular trends in wireline evolutions, which we're well positioned to capitalize on based on the acquisitions of Ixia that we have made, and we continue to see traction there. Not to mention the newer additions to our go-to-market with automotive and with next-generation semiconductor nodes. So we run a diversified business, and I think that's a source of greater stability for us and over time. And the second part of the supply chain question that you asked is, at the beginning of last year, we took a series of actions to basically redesign our products to second source components, and we had a -- we've talked about it on earnings calls. And all those actions have really enabled us to do better than we expected every quarter. But as we think about the supply chain, I speak with a number of our semiconductor supply chain partners, and they're all putting actions in place to obviously increase capacity, but it still continues to be a constrained environment. We're not back to this pre-COVID sort of supply environment yet and might take all of '23 to get there from our best information right now.

David Ridley-Lane:

Sure. You talked about some of the headwinds to revenue in the first quarter, but one tailwind not mentioned is pricing. And just sort of wondering how significant is pricing today versus more normal levels. I mean you're giving a couple of points tailwind from that. And then what type of volume growth is really embedded into first quarter's guidance?

David Ridley-Lane:

The type of volume growth is embedded in the first quarter guidance.

David Ridley-Lane:

Sure. And as a follow-up, another tailwind here is autos, right? I think last quarter, you mentioned that it's basically doubled over the last two years. This quarter, you mentioned $500 million in orders. So it's nearing close to 10% of your orders in this fiscal year. Do you feel like the trend there is kind of I don't want to say, not cyclical -- not subject to sort of macroeconomic condition, but certainly has a strong secular element to it.

Operator:

Our next line of question comes from the line of Rob Mason with Baird. Your line is now open.

Neil Dougherty:

Yes. So you're right. Obviously, our 16% or 16% plus has been our long-term target. We under spent that here in FY '22. I think a big function of that was the revenue outperformance within the year. If you remember, this time last year, we guided you to 6% revenue growth on the year, and we actually grew 12% on a core basis. And so, our R&D plans for the year were much more aligned with that lower level of revenue growth. So, I think as we go -- we certainly continue to see a large amount of opportunity for us to continue to invest in the future growth of our business, a lot of pull from our customers to do R&D work. And so, our intent is to revamp back towards 16% of revenue. Obviously, the salary administration here in the first quarter is going to help to move us in that direction. We may not get to 16% here in the first quarter, but looking at an exit rate that's at 16% or even potentially a little bit above by the time you get out to the fourth quarter is not out of the question.

Neil Dougherty:

Well, I certainly think over the longer term that as the supply chain normalizes, there will be an opportunity for us to reduce some of the working capital that's built up over the course of the last year. We see it in terms of inventory, at least inventory via the prices that we're paying for parts. We see it money tied up in terms of commitments to buy future inventory where we paid in advance for future delivery -- has been a use of working capital that, frankly, is new over the course of the last 12 months. And then frankly, the supply chain situation has significantly impacted the linearity of our revenue within the quarter. You can imagine when you move from more of a just-in-time environment where you're just building and shipping and building and shipping. We're doing a lot more build to a certain stage, wait for parts, finish and ship. And so, our revenue is tended to be more back-end loaded, which results in us carrying more receivables at the end of the quarter than we would if we were shipping in a more linear fashion. So again, I think it's a function of how does supply chain normalize and when does that eventually happen? That is -- you need a little bit of a crystal ball to answer that question. But when it does happen, we would see -- we would expect to see an ability to reduce working capital.

Jason Kary:

Thank you, Dante, and thank you, everyone, for joining us. As he mentioned, that concludes the call, and we wish you all a good evening and look forward to seeing you soon.

Operator:

Good day, ladies and gentlemen and welcome to the Keysight Technologies Fiscal Third Quarter 2022 Earnings Conference Call. My name is Amber and I will be your lead operator today. Please note that this call is being recorded today, Wednesday, August 17, 2022 at 1:30 p.m. Pacific Time. I would now like to hand the conference over to Mr. Jason Kary, Vice President, Treasurer and Investor Relations. Please go ahead, Mr. Kary.

Satish Dhanasekaran:

Thank you, Jason. Good afternoon, everyone. Thank you for joining us today. Keysight Technologies delivered another exceptional quarter with both revenue and EPS, our earnings per share exceeding the high-end of our guidance. Our outperformance reflects the effectiveness of our strategy, outstanding execution by our teams around the world, and the strength of our operating model. Keysight’s deep customer engagements with industry leaders and high-value differentiated solutions continue to drive broad-based demand across key technology megatrends. I will focus my comments today on three key headlines. First, outstanding execution by the Keysight teams around the world resulted in an all-time record revenue and earnings per share as we saw some supply constraints ease as the quarter progressed. Second, we saw strong order growth and sustained demand across all end markets and regions. Third, we are once again raising our full year outlook. We now expect to achieve revenue growth approaching 9% and earnings per share growth of approximately 20% for the full fiscal year. Let’s now take a deeper look at our results for the quarter. Third quarter orders grew 12% to $1.46 billion and outpaced record revenue, which grew 10% to $1.38 billion. Record EPS of $2.01, grew 31%. Orders and revenue growth in both business segments and across all regions is evidence of our ability to deliver value for customers as we manage macro and supply dynamics. Software revenue achieved an all-time high, outpacing total Keysight revenue growth, expanding our recurring revenue profile to further strengthen the durability of our business. Our software-centric solution strategy is a key differentiator in rapidly evolving design, systems emulation and modeling environments. We recently introduced PathWave Advanced Design System 2023 to address growing complexity in ultra-high frequency designs. We also announced that Keysight’s Open RAN solutions are moving to cloud-based deployment to support our customers’ needs as networks evolve to more software-enabled virtualized architectures. Turning to our business segments. The Communications Solutions Group delivered all-time record revenue and record third quarter orders. Commercial Communications achieved record revenue with growth across all industry segments and regions. Innovation dynamics across the Communications ecosystem remains strong, driving demand Keysight’s comprehensive end-to-end portfolio for both the wireless and wireline ecosystems. In wireless, 5G continues to represent an innovation-rich environment for the industry. Our differentiated software-centric solutions enable customers to address the growing complexity of use cases, frequency band combinations, real-world connectivity and mobility challenges. We continue to evolve our 5G platform to meet the requirements of emerging applications and newer versions of the standards. In collaboration with, Intel, Radisys, Vodafone and Wind River, we recently showcased an industry-first demonstration, deploying Keysight’s O-RAN and solutions to help reduce power consumption in a multi-vendor Open RAN network. AI-LINK, a provider of industrial IoT offerings, used Keysight solutions for end-to-end performance validation of cloud-native radio access network infrastructure. In wireline, we continue to see strong demand for 400 gig, 800 gig and photonics applications. We recently collaborated with Nokia to demonstrate the first public 800-gig interoperability test, validating the robustness of ultra-high data rates in telco networks and data center environments for the expected increase in AI, ML network workloads. Record Q3 orders in aerospace, defense and government outpaced revenue, which grew 1% on a core basis versus a strong growth quarter last year. Budget appropriations began to flow as reflected in prime contractor spending in the U.S., while 5G investments continued to grow to address new use cases such as RADAR and 5G coexistence. We also saw strong strength in satellite and space, including new applications for nonterrestrial networks. Over the next several years, we expect this market will benefit from elevated investments in technology modernization. The Electronic Industrial Solutions Group delivered double-digit order and revenue growth for the eighth consecutive quarter, with momentum from continued investments in next-generation technologies across automotive, industrial IoT and semiconductor end markets. In automotive, we are pleased with the continued broad adoption of our solutions portfolio, with the business nearly doubling over the past 2 years. Orders grew strong double-digits for the sixth consecutive quarter, and we delivered all-time record revenue. Keysight’s contributions to the advancement of EV and AV technologies, which include vehicle intelligence, connectivity, power and security are fueling momentum with leading car manufacturers and helped us secure wins with giga factories around the world. Keysight’s award-winning Radar Scene Emulator is the only solution on the market to imitate realistic roadway scenarios in a lab environment, and was chosen by a leading U.S. auto manufacturer for testing and validation of autonomous drive systems. This quarter, we completed another tuck-in acquisition in the automotive space, further adding to our software technology and technical staff focused on vehicle-to-everything communications. We continue to invest as we target evolving opportunities in the future of transportation. In general electronics, we achieved double-digit order growth and all-time record revenue as investments continued in digital health, IoT and advanced research. In educational research, Keysight is partnering with global leaders such as Nanyang Technological University in Singapore to advance 6G technology. Together with Sauce Labs, our Eggplant business delivered artificial intelligence-driven testing of enterprise applications. The acceleration in our general electronics business reflects the broad scope of our portfolio of leading technology solutions. Record orders for our semiconductor solutions resulted in ninth consecutive quarter of double-digit order growth driven by capacity expansion of mature foundries to address pent-up demand in the market and investments in advanced processes. Keysight’s PathWave design solutions expands our collaboration with major foundries beyond parametric wafer test into emerging applications like silicon photonics and next-generation design and simulation applications. While we continue to successfully execute our strategy, we recognize the near-term macroeconomic uncertainties. Keysight’s sustained performance over time is evidence of the resilience and durability of our business. Our resilience is an outcome of enduring partnerships with market-leading customers with early engagement to develop software-centric solutions that enable them to solve their most critical development challenges and achieve their first-to-market goals. Durability is a product of our flexible operating model designed to quickly respond to variations in demand while investing in critical long-term priorities. These strengths give us confidence that we can navigate uncertainties, and continue to deliver superior results going forward. Of course, all of this is made possible by our talented people. Steadfast execution by our teams, especially in a challenging environment, is proof that our Keysight leadership model delivers results, empowering our inclusive and diverse culture which fosters collaboration, high performance and innovation. We recently released our first diversity, equity and inclusion report as we renewed and strengthened Keysight’s longstanding commitment to DE&I and to being a great place to work for our global workforce of more than 14,000. With that, I will turn the call over to Neil to discuss our financial performance and outlook.

Jason Kary:

Thanks, Satish and Neil, for your comments. Amber, would you please give the instructions for the Q&A?

Jim Suva:

Thank you and congratulations to you and your entire team and company. My question is…

Jim Suva:

Yes. Automotive traditionally hasn’t been a big focus area for Keysight. You provided a little bit of commentary on it, but it appears that the car of the future and all the cars that are rolling out have a much bigger need for – whether it be EV, battery calibration, sensors positioning. How much is automotive for you? What has kind of been growing? And importantly, is there like long-term visibility? Are you in that – in the production side of things also, or just only in the R&D traditionally, I think about you more as R&D, but it seems like you’re kind of a little bit more into production or long life on automotive? But if you could pontificate on automotive sector, a little bit, that would be great. Thank you.

Jim Suva:

Thank you so much for details and clarification and congratulations.

Operator:

Thank you. Our next question comes from Matthew Niknam with Deutsche Bank.

Satish Dhanasekaran:

Maybe I’ll get started, Neil might want to add some comments here. I’ll say on the supply chain front, I did reference that we’re very pleased with the execution. It’s been now three or four quarters since we put the program in place to build out our capabilities to second source, extend our partnerships with suppliers tighter and ongoingly engaged with our customers on lead time reduction activities. So those have progressed very nicely. And as the quarter progressed, we saw some of the constraints get better as the quarter progressed, which resulted in the upside that we were able to generate in revenue, and delivered a very strong record revenue this quarter. I would say, on the macro supply situation, it still remains challenging. It is a tale of two worlds. On one hand, you have improved visibility and improved supply for general-purpose electronics parts, but high-precision electronics, analog components still appear to have constraints associated with them. But nevertheless, we are very pleased with our execution, and we’re also confident about our guide, which is why we have actually taken up the guide for Q4, and also for the full year to be now 9%. So that’s with regard to the supply situation. With regard to your second question on the long-term guide on targets, yes, I mean, we’re also very pleased with the progression – ongoing progression that we see quarter-after-quarter towards those long-term targets we set, both for growth and profitability. And that was goals that we set for 2023. We’re obviously executing very well towards those. And as we go into the fall, we will be having our 3-year strategic plan, and we look forward to updating you on any revised targets right after.

Operator:

Thank you. Our next question comes from Meta Marshall with Morgan Stanley. Morgan – Meta, apologies, your line is now open.

Satish Dhanasekaran:

Yes. I think our commercial communications portfolio is a diversified one that services both the wireless and wireline ecosystems, saw broad strength across both this quarter – and again, continued strength for the last few years driven by 5G on the wireless side and a number of technology evolutions like 400 gig, 800 gig on the wireline side. I’ll just hand it off to Mark to make some comments on the details for this particular quarter.

Unidentified Analyst:

Great. Thank you.

Chris Snyder:

Thank you. I have a question on the backlog, which is obviously running well above historical or even normalized levels. Is it fair to assume that pricing in the backlog is above the pricing that has been realized in revenues over the last couple of quarters? And what does that mean for forward price cost?

Satish Dhanasekaran:

And we’re very pleased with the 65% gross margin performance of the business in the backdrop of inflationary environment that Neil referenced.

Neil Dougherty:

Yes. Yes, that is fair to say. I mean if you look at the look at the order number that we put up last year, $14.91 in Q4 of last year, we are expecting orders to continue to grow. We have a strong funnel here entering the quarter. And so by definition, that implies additional backlog build in the quarter.

Chris Snyder:

If I could just squeeze – just a follow-up with that, Satish, very quickly, is there anything specific that is just driving the outsized strength in the demand backdrop? I’m just asking what should we be looking for or waiting for to kind of try to determine when demand is going to normalize back to the mid-single digit or even kind of high single-digit growth level?

Mark Wallace:

Yes. Well, Chris, we’ve said that it’s been broad-based, and it certainly has – you saw the growth come across all the end markets across all the regions. Our top customers, top 20 were up double-digit. We added more than 400 new customers in total during the quarter. Our indirect business and the channel was strong. So that shows the reach that we’re getting into new customers. And as Neil mentioned, our 6-month funnel is at or near an all-time high. We’re watching it very carefully. Some customers are being a bit more cautious in their spend, but it’s not reflected in our numbers, and it’s not reflected in what we’re seeing is overall demand going forward.

Operator:

Thank you. Our next question comes from Mehdi Hosseini with SFG. Mehdi, your line is now open.

Satish Dhanasekaran:

Yes. Thank you, Mehdi. I think the way we think about our business is we look at the new emerging technologies where customers are looking to innovate, and not just for a year or 2 years, but they are looking at a multiyear roadmap. That’s our focus, solving their more complex challenges, such as the ones you described in space and satellite, in commercial communications with both on the wireless and wireline side with evolving needs for capacity, which drives millimeter wave consumption, EV and AV, all of these are innovation-rich areas. We are making a unique contribution to enable our customers’ time to market. That’s the focus for us, and we will look to provide more insight as we move forward on these areas. Thanks for the input.

Satish Dhanasekaran:

Yes. No, I think you are spot on, right. You look at the backlog build, $2.5 billion roughly as we exit this quarter and then we have a whole quarter in front of us to exit the fiscal year. So, we fully expect that the backlog will continue to grow, which gives us increased stability. And as the supply situation improves, that just converts into earnings power for the company. The other area that I am very pleased with is the gross margin performance of the business in the backdrop of these inflationary pressures we are seeing, which, over time, as we have thought about the value we bring and continue to innovate with software and services, we have more upside to continue to grow that margin profile over time. And so we are not done at 65%, which should give us further room for growth. And then when we look at the next-generation innovation drivers that we are engaged with our customers right now, we feel pretty confident about extending that runway of growth as well.

Satish Dhanasekaran:

Thank you, Mehdi.

Mark Delaney:

Yes. Good afternoon and thanks very much for taking the question. I was hoping to better understand what you are seeing from customers in the semiconductor end markets in the near-term. I think some semiconductor companies have been seeing some cyclical weakness and perhaps cutting back on CapEx plans. Are you seeing anything related to that in your business? And to put that over the intermediate to longer term, you have had the CHIPS Act signed. And I am curious, are you seeing any improved long-term outlook for your business going into the semiconductor end market that you would attribute to the CHIPS Act.

Mark Delaney:

Thank you.

Adam Thalhimer:

Hi, good afternoon guys. Congrats on your first $2-plus EPS quarter. Just one on satellite and space, on satellite and space, how does that opportunity compare to some of the larger revenue buckets today, such as 5G and auto?

Adam Thalhimer:

Got it. Thank you.

Rob Mason:

Yes. Good evening. Thanks for taking the question. I wanted to see if you could give us an update around your PathWave rollout and just where you think you are in that process? When you introduced PathWave, it was going to be a multiyear effort to roll in your legacy applications. You are introducing new applications under the PathWave umbrella as well. How should we think about where you are at least on the legacy side in terms of converting those over? You talked about software outgrowing the overall company average as well. And just how to PathWave play into that?

Rob Mason:

Thank you. If I could ask one follow-up, just unrelated around the aerospace and defense government business, the orders continue to be pretty strong there. But how do you see the ability to get, I guess convert more of those orders to revenue here over the next quarter or two quarters, or is it still more of a supply chain issue now that the budgets are flowing – budget showing up in orders, or are you getting the ability to ship?

Mark Wallace:

And Rob, this is Mark. I will just add that the previous is another driver of growth, which is the intersection of many different segments or technology. We are talking about non-terrestrial network. We are talking about 5G deployment within aerospace defense. And then on top of that, you have the continuing long-term investment in defense modernization with funding beginning to flow from the U.S. government Department of Defense, and then Western Europe coming on very strong. So, there is a number of growth drivers on the front end, and that will continue for us moving forward.

Operator:

Thank you. Our next question comes from David Ridley-Lane with Bank of America. David, your line is now open.

Satish Dhanasekaran:

Yes. I think in the broader context, you look at the – what’s really changed significantly since the beginning of the year is the geopolitical environment, and it is going to drive more up in government investments for organic research across the globe. And for us, when we talked about drivers for the 5G business, we said near-term, it’s about the deployments. Medium-term, it’s about the millimeter wave and higher speed capabilities. And longer term, it’s about these new applications that are going to come online. And I think O-RAN has been one of those. We started to invest in that early. We are engaged in the O-RAN ecosystem. In fact we had the – we hosted the O-RAN consortium in our facility in Santa Rosa in this quarter to continue to drive the standardization around this nascent ecosystem. So, it’s an emerging opportunity, very exciting. Again, the – some of the strengths of the company with software continue to play into it. Now, with regard to immediate impact of public funding, your direct question, it’s really hard for us to assess that, but it’s definitely favorable as we think about where we invest and how we monetize.

Neil Dougherty:

Yes. I mean I think when we think about pricing in the – let’s start over the longer term kind of outside of this recent inflationary environment. Our goal is always to capture the value that we are bringing into the marketplace. So, we have – and regularly assess our prices relative to the competition and the value that we are bringing into the marketplace and adjust them accordingly. I think in this inflationary environment, there has become little bit of a cost element as not just our suppliers, but our competitors and people across the broad ecosystem have been increasing prices in response to that inflation environment. So, I think you are correct in assuming that our pricing increases have moved northward over the course of, say, the last 12 months to 18 months in response to that inflationary environment.

Operator:

Thank you. There are currently no further questions in queue. There are no further questions in queue, so that concludes our question-and-answer session for today. I would like to turn the conference back over to Jason Kary for any closing comments.

Operator:

This concludes our conference call. You may now disconnect.

Operator:

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Second Quarter 2022 Earnings Conference Call. My name is Tia, and I will be your lead operator today. Please note that this call is being recorded today, Tuesday, May 17, 2022, at 1:30 p.m. Pacific Time. I would now like to hand the conference over to your host, Jason Kary, Vice President, Treasurer and Investor Relations. Please go ahead, Mr. Kary.

Satish Dhanasekaran:

Thank you, Jason, and thank you all for joining us. Welcome to the second quarter 2022 earnings call and my first as the CEO of Keysight. I am humbled and honored to be Keysight's CEO and excited about the future. I would like to thank Ron Nersesian for his visionary leadership of the Company, which has provided us a solid foundation to build on. Over the last decade, I've had the honor of working closely with Ron and benefited greatly from his experience in many different roles I've held since joining the Company 16 years ago. This is a great time to be at Keysight as we remain focused on our core purpose of accelerating innovation to connect and secure the world. Keysight delivered exceptional results in quarter two, driven by strong execution and broad-based demand across the business. The team focused on innovating and solving customers' design and test challenges while successfully navigating the ongoing supply chain and geopolitical challenges. I will focus my comments today on 3 key headlines. First, we delivered record quarter two orders, capitalizing on the robust end-market demand for Keysight's high-value differentiated solutions. Our focus on delivering first-to-market solutions is enabling us to uncover new emerging applications, adding to our momentum. Second, we achieved record revenue, strong operating margin performance, resulting in record earnings per share, which grew 27%, demonstrating the durability and resilience of our business. Third, we are raising our outlook for the year based on our strong performance in the first half and continued momentum. We now expect to achieve revenue growth approaching 8% and earnings per share growth in the range of 14% to 15% for the fiscal year. Let's now take a deeper look at our results for the quarter. Second quarter orders grew 9% to $1.46 billion and outpaced revenue, which grew 11% to a new record of $1.35 billion and was $41 million above the high end of our guidance. We achieved gross margins of 65%, operating margin of 29% and record EPS of $1.83, exceeding the high end of our guidance by $0.14. Also with the ongoing equity market volatility, we again capitalized on the opportunity to accelerate share repurchases. These results are a reflection of our strong portfolio and our global team's application of the Keysight leadership model, which enables us to deliver consistent value to all stakeholders. We delivered these results despite many headwinds, including geopolitical challenges, inflationary pressures and continued supply chain disruptions. We continue to advance our software-centric solution strategy as the rapid pace of technology accelerates, our customers across end markets are seeking deeper engagements earlier in the design cycle and are adopting our software solutions. The capabilities of our PathWave software platform facilitate continuous stream of releases that matches the innovation cadence of our customers. This enables us to secure enterprise agreements with market leaders for high-value R&D solutions. Orders for software and value-added services like KeysightCare again grew double digits as we continued to grow recurring revenue this quarter. Turning to our business segments. Communications Solutions Group delivered record second quarter orders and an all-time record revenue. Within CSG, commercial communications achieved all-time record orders and revenue with double-digit order growth for the third consecutive quarter. Ongoing innovation and investments in our end markets spanning both, the wireless and wireline segments remained strong, driven by adoption of 5G, 400 gig, 800 gig and terabit and optical technologies. In wireless, the increase in the number of 5G device types continues to drive test and certification requirements. With our leading solutions portfolio, we expect to benefit from the continued investment in the evolution of 5G standards, including stand-alone 5G, Release 16 and beyond. In quarter two, Keysight announced collaborations with leading companies such as NTT DOCOMO, Telefonica and Analog Devices to enable a wide range of 5G applications, including O-RAN, which continues to gain momentum. In wireline, we're enabling the digital transformation, driven by cloud computing and telecom stack virtualization through our end-to-end solutions. We recently launched the industry's first 800-gig solution to enable data center design workflows for ultra-high data rates and energy efficiency. Aerospace, defense and government achieved record Q2 revenue, driven by double-digit growth in Americas and strength in signal monitoring, cyber and space and satellite solutions as well as 5G and 6G applications. Complex scenario emulations continue to drive the need for modeling and digital twin solutions with increasing software content. Our leading network analyzer platform and phased array test solutions enable increasingly complex satellite communication design and test requirements. Increasing defense budgets in the U.S. and Europe are expected to provide support for higher spend going forward. CSG is well positioned to capitalize on growth by enabling innovation in our end markets through our broad and synergistic portfolio, including wireline, wireless, cybersecurity, satellite and space solutions. The Electronics Industrial Solutions Group delivered double-digit order and revenue growth for the seventh consecutive quarter, driven by automotive and semiconductor solutions. In automotive, all-time record revenue was driven by strong demand for our expanding portfolio of EV and AV applications. Keysight is capitalizing on strategic investments in the automotive and energy space, providing industry-first solutions that support new capabilities and use cases, such as our recently launched protocol test solution for in-vehicle networking. During the quarter, we secured EV wins with major OEMs across all regions. In addition, we're excited by the recognition of our new Radar Scene Emulator solution, including the 2022 Tech.AD Europe award. We saw strong demand for our semiconductor solutions, which delivered double-digit order and revenue growth. Investments in advanced semiconductor technologies, along with capacity expansion for existing nodes, remain robust. Over the next 3 to 5 years, we see solid customer R&D roadmaps for ICs for a broader set of applications. As an example, in Q2, we sold our first on-wafer silicon photonics parametric test solution to a major semiconductor fab to develop and manufacture next-generation data center transceivers. We believe this trend represents long-term opportunities for Keysight's R&D solutions portfolio. Our general electronics business achieved all-time record revenue as investments continued in manufacturing and device development for consumer and industrial IoT, digital health and advanced research. We're seeing active investments globally in fundamental research in terahertz and quantum technologies. For example, we recently announced a collaboration with National Research Foundation of Singapore's quantum engineering program to accelerate research and development and education in quantum technologies. The strength of our general electronics business reflects the broad nature of applications for our solutions. Before I wrap, I'd like to acknowledge and thank our more than 14,000 employees worldwide for their commitment to our customers around the globe and for their passion in delivering market-leading solutions. I'm proud to share that Keysight was recently named as one of Fortune 100's best companies to work for in 2022. This is a recognition of our inclusive and diverse culture exhibiting value for collaboration, high performance and innovation. Our culture also places high value on corporate social responsibility. We recently released our 2021 CSR report, highlighting our progress in environmental, social and governance efforts worldwide and announcing new goals to track through '22 and into '23. I believe Keysight has a bright future ahead. I look forward to working with the team to execute our strategy and continue to deliver greater value for our customers, shareholders and employees. With that, I'll turn the call over to Neil to discuss our financial performance and outlook. Neil?

Jason Kary:

Thank you, Neil. Tia, will you please give the instructions for the Q&A?

David Ridley-Lane:

Good afternoon. Wondering if you have seen an uptick in any supplier decommitments over the last few months. Obviously, China shutdowns have impacted a lot of electronic manufacturing, component suppliers and so forth. Wondering if you have seen any of that show up in your operations.

David Ridley-Lane:

And as a quick follow-up to that, have your own lead times, the time to -- expected to ship the product, have those actually started to decline, or are they stabilizing at elevated levels? Thank you.

Operator:

The next question is from the line of Matt Niknam with Deutsche Bank.

Neil Dougherty:

I'll take the first part of that, the question about the guide. As we've already stated, our revenue situation is still highly constrained by the supply environment. And we had significant outperformance in Q2 as we navigated the tight supply environment and did better than we expected. And so, -- but what you can read into that is that a significant portion of our Q2 outperformance was shipment of orders that we had originally or going into the quarter had scheduled to be in Q3. And so, that's great news, and we're pleased with that. But that -- on a quarter-over-quarter basis, that can be a significant impact. I would say that the guidance reflects our best estimate as we see it at this point in time. This quarter-to-quarter perturbations can be very difficult to call in this environment. We certainly have the backlog to do better if -- depending on how incoming supply works. And I think the point that we want everybody to focus on is that we are taking up the full year guidance significantly from 6% to 7% growth to approaching 8%. And that 8% growth, as you noted, has kind of new and significant FX headwinds. We saw a very significant strengthening of the dollar within our fiscal second quarter. We now have a 2-point year-over-year headwind in the second half that we're baking into account. And on the full year basis, we have a 1.5-point relative of FX. Just from November, when we put out the 6% to 7% guide to where we are today, saying approaching 8%, there's a new 1.5% FX headwind baked into that. And so, we feel very good about the situation as it currently sits and are pleased to be raising estimates for the year.

Operator:

The next question is from the line of Mark Delaney with Goldman Sachs.

Satish Dhanasekaran:

Yes. Thank you. I think, the auto business is very exciting for us for more than one reason, I would say. First, very strong quarter, obviously, building on many quarters where we've seen a very strong uptick in the business, primarily driven by this decade-plus long trends of electrification, autonomous driving. And we're actually feeding a number of these engineering labs with our tools and capabilities and solutions designed for this end market. We're engaging with the OEMs globally. We've had some successes, as I reported, in this quarter. And we're also working with the entire ecosystem with the Tier 1, Tier 2 suppliers, the semiconductor houses that feed the auto and the test labs that are just growing across the world. So, it's a growing ecosystem. We're expanding our portfolio into EV, particularly around battery test, charging test, in-vehicle network testing as an example. And in AV, we're very excited by the new solution that we have offered for autonomous drive emulation, which is enabling in-loop, real-time, synchronized sensor evaluations, and this is a build on our 5G platform and capability. So, we're very pleased with the progress we're making, and we know that we have a long runway ahead with automotive.

Neil Dougherty:

Yes. So, I think you need to take a close look at our Q4 performance in FY21, which was a bit of an outlier at 31% operating margin, a full almost 4 points higher than the prior -- the sequential quarters leading up to that. And so, I think as you -- and the other -- one of the big drivers within the fourth quarter of last year, if you look at it, we had a sequential decrease in R&D investment that was quite substantial going from Q3 to Q4. And that is atypical. And so, we would expect increasing investments on a sequential basis as we move from Q2 to Q3 and then again as we move from Q3 to Q4 as we invest in the future and the future growth of our business. And so, again, we remain optimistic about our business. And some of these quarter-to-quarter perturbations can be difficult to call, but we are raising our both, revenue and EPS guidance for the year quite substantially and are focused on executing.

Samik Chatterjee:

Satish, congratulations on your first earnings call in the CEO role. I guess, in your prepared remarks, you did mention the higher defense budgets, and if I could start with that. I mean, when should we be realistically expecting the higher defense spending budgets to start impacting sort of your order trends? What is the typical sort of time line that you see -- have seen in the past in terms of when you start to see the flow-through of that into your order trends? And I have a quick follow-up.

Mark Wallace:

Yes. Samik, this is Mark. I think just to add to Satish, the budget in the U.S. was approved. It was increased. And as we've been watching our customers, both the direct government and the prime contractors, we expect some of that funding to start flowing to new program starts here in our second half. So, we look forward to that. And as you probably know, as many of the programs nowadays are multiyear, this will flow into the fiscal year '23 and beyond. And you've been following what's going on in Western Europe as well with increased spend from the NATO nations, we'll see how that flows through. We expect that to be favorable as well. And then, I think the last thing I'll just mention is there are other aspects of this industry segment that are representing new growth opportunities for us around space. Commercial space in particular is a very hot area for us we continue to focus on. And then, the continuing modernization that we've been talking about for many quarters or years is a long-term trend that we're very excited about. We see a strong funnel of opportunities going into the future.

Neil Dougherty:

Yes. So, in prior quarters, we've talked about an expectation or thinking that we would see some material improvement in the supply chain situation in the second half of this year. To this point, we have not seen that. And in fact, I think if you look broader across the tech industry, there's an argument that things got incrementally worse in Q2, are more challenging, driven by the Russia-Ukraine conflict as well as the COVID shutdowns in China, even though those COVID shutdowns don't impact us directly. I think for us, we look at the items that we can control, our own capacity both for finished goods as well as for the subcomponents that come out of our fab and technology centers that feed our instrumentation. We look at our relationships with our suppliers, some of the engineering efforts that we have to quantify -- or to qualify new parts or secondary sources to open up new sources of supply. Those things are paying dividends for us and have contributed to the revenue performance that we've been able to deliver. And so, -- but as we look forward, and you asked specifically about the guide for the second half, we are still very much supply chain-constrained. And so, what that really bakes in is kind of our direct line of sight to delivery of the piece parts that we need to get products out the door and into the hands of our customers. It's a situation that's being very actively managed, but I think we're doing a good job of getting product into the hands of our customers on a time line that is acceptable to them.

Operator:

The next question is from Meta Marshall with Morgan Stanley.

Neil Dougherty:

I'll take the first part of that, and then we'll let Satish or Mark address the silicon photonics part of the question. So, yes, with regard to the OpEx spending and the return of T&E and facilities costs, we didn't -- honest answer is, we did not see a lot of that in Q2, right? The Omicron spike, if you will, was kind of right in the middle of our second quarter, and we did not see any meaningful kind of return to -- of travel, entertainment and return to office. We have recently, more at the beginning of Q3, started to bring our employees back to our physical sites in . We are starting to see travel and entertainment not return to normal, but starting to reramp here more of a -- as more of a third quarter event. As regard to inflation, we're seeing cost of inflation in a number of different places across the P&L. And I think our action -- or our challenges with managing that is to capitalize on the differentiation that exists in our portfolio and look to monetize that where we can and continue to bring differentiated high software content solutions to the marketplace so that we can continue to manage that. I think if you look at the margin performance of the business, we're doing a good job to date managing those inflationary increases across the P&L.

Meta Marshall:

Perfect. Congrats, guys. Thanks.

Operator:

Thank you. The next question is from the line of Chris Snyder with UBS. You may proceed.

Neil Dougherty:

Yes. Well, first, you're absolutely right. We do not expect that we're going to reduce backlog at all this year. In fact, we would estimate in the current supply environment, which we expect to be challenging through the remainder of our fiscal year that we're going to continue to add to backlog. I think, how the backlog eventually winds its way from where -- from its current elevated levels to a more normalized level is really a function of how the broader supply chain situation resolves itself, right? And it's only educated guesses at this point because the honest answer is we don't know what that's going to look like. But I'm not expecting that there's going to be a step-function improvement across the supply chain that allows us to flush backlog over a one- or two-quarter period. I think it's going to be much more a function of us slowly bringing our quote and lead times on products down and slowly working that -- the backlog down to more normalized levels.