Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal First Quarter 2015 Earnings Conference Call. My name is Mike, and I will be your lead operator today. [Operator Instructions] Please note that this call is being recorded today, Thursday, February 19, 2015, at 1:30 p.m. 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.

Thank you, Mike, and welcome, everyone, to Keysight’s first quarter earnings conference call for fiscal year 2015. With me are Ron Nersesian, Keysight President and CEO; and Neil Dougherty, Keysight's Senior Vice President and CFO. Joining in the Q&A after Neil's comments will be Guy Séné, Senior Vice President of Measurement Solutions and Worldwide Sales; and Mike Gasparian, Senior Vice President of Customer Support, Services and Marketing. You can find the press release and information to supplement today's discussion on our website at investor.keysight.com. While there, please click on the link for Quarterly Reports under the Financial Information tab. There you will find an investor presentation and we will also post a copy of the prepared remarks following this call. Today's comments by Ron and Neil will refer to non-GAAP financial measures. You will find the most directly comparable GAAP financial metrics and reconciliations on our website. We will make forward-looking statements about the financial performance of the company. These statements are subject to risks and uncertainties, and are only valid as of today. The company assumes no obligation to update them. Please review the company's recent SEC filings for a more complete picture of our risks and other factors. And now, I'd like to turn the call over to Ron.

Thank you, Jason, and welcome, everyone. I will start by sharing 4 headlines regarding Keysight's Q1 results. First, revenue was above the midpoint of our guidance, operating margin was at the high-end of our guidance, and non-GAAP earnings per share was $0.56. While this is our first time reporting quarterly results as an independent company, it is the fourth quarter in a row that we've delivered financial results above expectations. Second, we are further ahead on our stabilization plans than where we expect expected to be at this point. Third, we remain committed to creating shareholder value and to returning to market growth rates. We continue to focus intently on transforming our portfolio and receive several distinguished industry recognitions in Q1 for a modular PXI Vector Network Analyzer family that is a proof point of our ability to innovate beyond current market offerings. And fourth, now that we have one quarter of results under our belt as an independent company and we have validated our models, we are changing from guiding operating margin to guiding non-GAAP earnings per share. Let's move to the specifics of our results. Keysight Q1 revenues of $701 million increased 4% year-over-year or 7% on a core basis, which excludes the impact of currency and acquisitions and were $6 million above the midpoint of our guidance. First quarter orders of $691 million decreased 1% year-over-year, or grew 1% on a core basis. Keysight achieved strong profit margins that were above our guidance generating operating profit of $120 million and an operating margin of 17.1% for the quarter and non-GAAP earnings of $0.56 per share. Turning to our end market performance. Total aerospace/defense revenues increased 22% compared to Q1 of last year when aerospace/defense was down significantly due to delays in the U.S. budget approvals. This quarter,…

Thank you, Ron, and hello, everyone. As Ron mentioned, Keysight is off to a strong start in its first quarter as a fully independent company. Before I get into the details of our results, please note that my comments will refer to non-GAAP figures. In addition, we are now reporting results, not only for Keysight in aggregate, but for our 2 operating segments: measurement solutions and customer support and services. The segmentation of our business remains consistent with our SEC reporting in both our Form 10 and our FY '14 10-K. Now turning to our results. First quarter revenues of $701 million were up 4% year-over-year, or 7% on a core basis, which excludes the impact of currency and acquisitions. The impact of acquisitions was immaterial, so currency accounted for the full 3 percentage point headwind versus Q1 of FY '14. Keysight invested in R&D at a rate of 13% of revenue in the first quarter, which was in line with Q1 of FY '14. Operating margin of 17.1% was down 50 basis points versus the same period last year as we began to see the impact of the separation related dissynergies. Both revenue and operating margin were above the midpoint of our guidance range. This is the fourth consecutive quarter that we have delivered in line with or better than guidance, as we continued to demonstrate the strength and discipline of our operating model. Taking a closer look at revenues. The regional revenue breakdown was largely consistent with prior periods, with 38% of revenues coming from the Americas, 19% from Europe, 33% from Asia, excluding Japan, and 10% from Japan. On a constant-currency basis, regional revenue grew 16% in the Americas, declined 1% in Europe, declined 5% in Japan and grew 7% in the rest of Asia. Last quarter,…

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

[Operator Instructions] First question is from Patrick Newton from Stifel.

I guess the first one is just on the market growth rate. I think, last quarter, you cited an expectation of about 2.5% to 3.5% growth for the market and the expectation that Keysight would grow slightly below that rate. Is that still -- has that changed at all, due to the FX impacts? Or is that still a realistic market growth rate?

When you look at the core growth rate, Patrick, I think, the core growth rate is right, as far as the FX impact, there's no doubt that currency is affecting the growth rates of our business and other players' business going forward. But the good news is, for Keysight, we're hedged, so it doesn't affect our bottom line. You'll see our operating margin percentage creep up because unless revenue due to FX will generate the same profitability and generate a little bit higher operating margin such as why we were at 17.1% this last quarter.

Okay. And then I guess you made comments about transforming the business and making investments to drive growth. Can you help us understand how we should think about that from an organic basis? And maybe where R&D trends should go on a go-forward basis? And then, from an inorganic basis, can you help us understand what your M&A strategy is? Is there any type of, I guess, size that you're willing to, I guess, consummate at this time? Any type of leverage ratios we should look at or target multiples? Just anything to help us gauge how we should think about your M&A appetite on a go-forward basis.

Unfortunately, at this point, because of the limited number of prospects that exist in the competitive environment, we're not commenting on what we plan to do in M&A. I will tell you though that our focus, which is all around improving our wireless communications portfolio, improving our modular offering and improving our software capability and extracting above-market growth rates from those 3 areas, would be the areas that are very important to us. Those are the main areas, but we will also look at other opportunities that seem to make sense. As far as leverage ratio, I'll let Neil answer that.

Yes, so one of the things that we've stated is that we do value our investment-grade credit rating. And as a result of that, I think we will look to manage leverage in or around the 2x EBITDA level. The other question that you asked as part of that was, what we would expect with regard to R&D investment to drive organic growth. And as we've stated in the past, we're going to look to increase R&D this year to 13% of revenue. We spent the 13% of revenue in the first quarter on, albeit a seasonally low revenue quarter, but you'll see the absolute dollar R&D spend ramp throughout the year, and we should look to spend very close to that 13% for the full year of FY '15.

Okay. And I guess, just one last clarification question, Ron, and kind of in answering where you want to see growth, you specifically brought up communications, and that's an area whether, from new products, it sounds like a lot of interesting new product announcements out there. You did have a private competitor that in their kind of annual filing said that the saturation effects are becoming evident in production test and measurement for the wireless communications industry. I'm curious if you're seeing any saturation effects? Or you sound like communications is going to be part of the growth drivers. Are you gaining share? Or what is kind of driving the -- maybe the difference of opinions between competitors?

Sure. We see the same thing that you see with the same private competitor, and we've noted that and noted that over the last year or almost 2. Fortunately, it's in one sector of the communication area, and that's in the production and test environment. So one of our long-term strategies that we've been talking for years is to move more and more of our portfolio from production test into R&D. The manufacturing environment or production environment is one in which there are more and more competitors, the barriers to entry are lower because the performance needs are lower, and it's all about cost and we've seen some competitive moves that are all just about price. So we continue to focus more and more of our investment in research, in development. And as of now, I'm happy to report that slightly over half of our total business is in R&D. Where, in the past, manufacturing was a bigger percentage for us. But that's a concerted strategy that we have to invest where there is still good opportunities to extract value and produce good returns. And we see that much more in R&D than we do in production. We are opportunistic in certain areas in production, but our primary focus is in R&D.

Next question is from Brandon Couillard with Jefferies.

This is Sachin in for Brandon. Ron, in the communications business, I know this may be a bit early. But when do you think we will start to see the next 5G cycle begin to impact demand in the wireless R&D arena? And do you view 5G as a possible fiscal year '16 opportunity or further out?

We're starting to see -- right now, we see some very small investments, we're partnering with different players to go ahead and help develop the technology and we're working with folks like China Mobile to move that forward. But you will not see the volume for a period of time. I'm going to let Guy give a little bit of color commentary, but as he will explain to you, it's going to be a while before that really ramps in the P&L. Guy Séné: If I can add what -- some more colors on this. Clearly, 5G will not be deployed, at the earliest, before 2020. That's really the goal. And between now and then, obviously, there's a lot of research that is going to happen, and we are part of multiple consortium across the world who also have direct contacts and relationships with market makers. We have announced a memorandum of understanding with China Mobile to work with them on developing the technology. But it's very, very early phases. We're taking some orders currently. We have taken deals with research institutes that do some early research for some of this technology that need to happen. But I would not envision big shifts before at least 2 more years.

Got it. And also, Ron, would you give us an update on the traction you're seeing from new products, particularly in modular, EXM and UXM?

Sure. At this point, what typically happens on the UXM side, in particular, is people will buy those products and they'll buy them for R&D. And they'll buy one, and they'll see how they like it and then they'll start to populate that around the lab. We've seen some good traction in that area, although it's certainly a multi-year rollout, or an effort of ramping. We also add new software capability along the line, but I'll let Guy talk about both of them. Guy Séné: Yes, since we introduced this product about 9 months ago, we're definitely shipping them in volume now. For the manufacturing more focus product that is the EXM, we have now been qualified by all the major chipset vendors and manufacturers, and this is a major milestone that we had in our plan to go. And then on the R&D side, we're making very good progress, especially in China where there's a number of investments going, and we keep adding differentiated features and performance on this platform, especially oriented versus the LTE advanced solutions that people will look at more and more. In fact, more of this will be most likely seen at the Mobile World Congress that is this major event for the mobile industry that will happen in a couple of weeks, and we will have a number of our products there.

Next question is from Richard Eastman from Robert W. Baird.

Ron, could you just speak to a minute to the kind of the general purpose in industrial computer semi piece of the business being down 6%. I think the semi was recognized to have had a really tough comp. But year-over-year, did the industrial and computer pieces of that grow were they up in the quarter year-over-year?

Sure. Overall, we don't break it down by each one of the subsegments. In industrial, it was roughly flat on a core basis. There was a little bit of currency headwinds, but on a core basis, we were roughly flat on the industrial side. And the computer and semi business, which we report together, was down. But again, that was driven by really the semiconductor market, which had a spectacular year last year and delivered some great growth for us.

And when you look at the by end of market, when you look at the industrial computer semi, the aerospace/defense and com, it strikes me, were these growth rates kind of at plan? Or did we see a little better performance on the A&D side and maybe a little softer on the industrial computer semi? Or -- could you just parse that out a little bit?

Sure. Overall, there were no big surprises. Last year, in Q1, we were surprised that the aerospace/defense budget dollars were not passed out as quickly as the end-users and the government told us that they will be placing orders, and they were very frustrated to actually place the -- not get the money to place the orders, so we had a relatively low compare. So we expected that to bounce back. There was nothing that was significantly off from what we'd expected and what we were expecting to happen. The biggest thing is that Russia, we had expected Russia to decline, I had talked about that a couple of quarters ago. It held up a little bit longer than we thought. But now, we're seeing 2 effects: one, we're seeing clearly the fact of the FX or the currency lowering the amount of revenue that we get in U.S. dollars because they -- folks do not have enough buying power. So the bottom line is they can't buy the equipment that they want to buy because the ruble has depreciated so much. And that's probably the, I'd say, the strongest point is that Russia has finally contracted like we thought it would have a couple of quarters ago.

And just a -- and as a follow-up, the customer support and services business. Should we be thinking about the up margin kind of stabilizing more in this mid-teens, 14% range? And is there anything on the used equipment side of the business that's captured in this customer support services that gives you any feel one way or the other for strength of end market demand?

I'll take the first part of that question, with regard to the profit margins in CSS. Actually, I think you should not think about this business stabilizing at this new lower profit level. We have a few things -- we did make this -- fix this investment in technology, in capacity to service customers in the aerospace business. Those investments had to be made in advance of the recognition of that revenue. And then as I did say, based on the use of historic drivers to essentially split what is a pretty significant shared infrastructure cost, we did see some expenses move from the much larger measurement solutions business, you don't really -- it's almost unnoticeable at that segment level, but at a business that's less than $100 million in quarterly revenue, you move the dollars over and has a material impact on profitability. So we will reevaluate those drivers to make sure that they're appropriate for those businesses going forward. I don't have an opinion on that yet, and I'll reserve judgment. But we'll take a look at those and make sure that we've got an appropriate driver to split our shared infrastructure costs.

Okay. But it's not a structural issue within this segment, so to speak? I mean it's more around the allocation, and obviously, I understand IT investment, that makes sense. But there's nothing structurally that says this business should be 5, 6 points operating profit lower.

Absolutely not. There's no doubt. For instance, we were very happy that we won some nice big contracts, multi-year contracts to basically provide calibration -- on-site calibration services for multiple vendors from some larger aerospace events players. The key thing is we have to ramp up and put some expenses in place to put our folks in. But we expect our profitability in this segment to be back up once that -- once we start receiving the revenue that corresponds with that and once we adjust the drivers properly. But we see the service, the whole service sector, to do 2 things for us: One, it's a good growth opportunity for us in the future; and two, it will be solidly profitable in the upper teens to 20% range. And three, it will be much more stable over time. So it will provide more of a recurring revenue base for us. As you see, in installed base of equipment, if our $3 billion a year worth of equipment lasts 10 years on average and many pieces of our equipment are out for 20 years, that's $30 billion worth of equipment that's out there that needs to be calibrated and repaired on an ongoing basis. So I really am enthused about the ability to move to more of an annuity model that brings in very solid profitability and helps derisk in the volatility that we have.

And is it -- can you make any inferences from the marketplace itself on your used equipment sales? If the demand is better, meaning demand picks up and that should translate into new equipment at some point? Or is there anything to be seen there and is there any change of any consequence?

I would just say that our used equipment inventory is low. So that implies that we do not have much equipment in that area and that it's been pulled out. I wouldn't call any dramatic shifts at this point but our used equipment is -- inventory is lower-than-average, due to the sales of that over the last year.

And the question comes from the line of Jim Covello with Goldman Sachs.

In the communication segment, the strength you referenced in the components supply chain for mobile devices, how seasonal versus cyclical do you think that is? And then how do you feel about the quarter-to-quarter share shifts amongst you and your competitors in that segment?

Yes, Jim. Deal by deal that obviously, when you're talking about some of the bigger deals, you'll see the share jump around. But we have been very, very, very solid on the component side. So a lot of times, over the past years, everybody's been talking about winning final production test, and talking about that as far as winning major manufacturers. We have stated for years that we really see that our opportunity to create value is further upstream. What we do first with EDA design software, what we do for component test, what we do for validation way before it even gets into production. We're holding our own and doing very nicely. We came out with some new products that Guy has just talked about, that are getting traction. But you see network analyzers that are a big part of that, and we are #1, and we have more -- we sell more network analyzers than everybody else in the world put together. So we feel very good about our share in that area. As far as the cyclicality on the component test, it really is more on when phones are produced. So as you know, there is a component -- that there's a seasonal component to that, but as we see people with the capacity moving up and down, we see different types of purchases. One of the things that you also see on our website or you'll see in a press release from 2 days ago, we introduced a brand-new family of ENAs, which are Economy Network Analyzers that are exceptional for component test, and you'll see roughly 5 or 6 brand-new products that were introduced that are very, very powerful in this space. So not only do we have over 50% share, we just took our game up to a whole -- a whole another level.

That concludes our question-and-answer session for today. I would like to turn the conference back over to Jason Kary, for any final comments.

Thank you, operator. Ron, I'll turn it over to you for your final comments.

Well, I'd like to thank everybody for joining the call. I am pleased that Keysight delivered solid results as we guided one quarter ago. As I close, I'll remind you of the key attributes of Keysight. We're the global electronic measurement technology and market leader. Our business model delivers strong margin and ROIC performance and cash flows. And as a $2.9 billion company in a $12 billion market, it is clear that we have opportunities for growth. Using our unique formula that combines technology leading hardware and software and our global network of experts, we are focused from the front line employees to the executive staff on maintaining strong profitability, while using our innate drive to go ahead increase our growth rate and deliver long-term shareholder value. Thank you very much for joining us today, and have a great day.

Thank you, Ron, and thank you, ladies and gentlemen, for joining us on the call today. A replay of this call will be posted on our website. As always, our Investor Relations team is available, if you have any questions. Thank you.

This concludes our conference call. You may now disconnect.