Good day, ladies and gentlemen, and welcome to Keysight Technologies’ Fiscal Second Quarter 2018 Earnings Conference Call. My name is Shawntelle, and I will be your lead operator today. After the presentation, we will conduct a question-and-answer session. [Operator Instructions]. Please note that this call is being recorded today, Wednesday, May 30, 2018 at 1.30 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, and welcome everyone to Keysight’s second quarter earnings conference call for fiscal year 2018. Joining me are Ron Nersesian, Keysight President and CEO; and Neil Dougherty, Keysight Senior Vice President and CFO. Joining us in the Q&A session will be Mark Wallace, Senior Vice President of Worldwide Sales; and Satish Dhanasekaran, President of the Communications Solutions Group. You can find the press release and information to supplement today's discussion on our Web site 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 along with Keysight’s segment results. Following this conference call, we will post a copy of the prepared remarks to the Web site. Today's comments by Ron and Neil will refer to non-GAAP financial measures. We will also make references to core growth, which excludes the impact of currency movements as well as revenue from acquisitions completed within the last 12 months. You will find the most directly comparable GAAP financial metrics and reconciliations on our Web site. We will make forward-looking statements about the financial performance of the company on today’s call. 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. I would also note that management is scheduled to present at the Bank of America Merrill Lynch Global Technology Conference on June 6th in San Francisco, as well as the Stifel Cross Sector Insight Conference on June 12th in Boston and the Credit Suisse Semiconductor Supply Chain conference on June 14th, which is also in Boston. We hope to see many of you there. And now I'd like to turn the call over to Ron.

Thank you, Jason, and thank you all for joining us. Today, I’ll focus my formal comments on three key headlines for the quarter. First, revenue grew to a record $999 million, which was well ahead of our guidance. We also achieved earnings of $0.83 per share, which was $0.02 above our guidance midpoint. Second, Keysight's core revenue and orders grew double digits and we achieved double-digit order and revenue growth in our Communications, Electronic Industrial, and Services Solutions Groups as demand for Keysight’s solutions in 5G, Automotive, and Services continued. And third, we are raising our outlook for the year. Let's now take a deeper look into our performance for the quarter. We achieved earnings of $0.83 per share and delivered strong order growth. Orders grew 23% in total, or 10% on a core basis. Broad-based demands across our markets, geographies, and channels drove our third consecutive quarter of double-digit core order growth. Q2 revenue grew 32% or 18% on a core basis to reach $999 million. Core revenue grew double digits across all regions, including our emerging markets. Additionally, I'm pleased to report that the shipment disruption from the wildfires is now behind us. This was completed one quarter earlier than expected and without a single order cancellation. During the quarter, we completed phase 2 of the Ixia integration. We have invested significant resources upgrading their systems and processes for long-term value creation. This included integration of all procurement, contract manufacturing, trade and logistics activities to leverage Keysight’s scale. In addition, we consolidated 28 sites to drive operational alignment and cost savings and absorbed many management and administrative functions for efficiency. This was an enormous effort and stabilization took longer than expected, impacting ISG's Q2 results. Many of these integration issues are now resolved and we will deliver the…

Thank you, Ron, and hello everyone. We delivered an exceptional top line quarter as we continued to execute on the strong demand we see in core areas of our business. Given the impact to the quarterly seasonality of our revenue due to the disruption from the wildfire, I will comment today on both our second quarter and first half results. For the first half of 2018, we delivered 8% core revenue growth, a year-over-year core operating margin incremental above 40% and 11% EPS growth overall. In addition, first half orders grew 30% in total, or 13% on a core basis, enabling us to exit Q2 in a strong backlog position. As expected, we saw a significant revenue ramp in Q2. We reported Q2 non-GAAP revenue of $999 million, which was well ahead of our guidance. This brought our revenue for the first half to $1.9 billion, up 25% year-over-year, which includes a 2 percentage point favorable impact from currency. Looking at our operational results for Q2, we reported gross margin of 60.3% and operating expenses of $399 million resulting in operating margin of 20.4%. We reported net income of $158 million and $0.83 in earnings per share on a weighted average diluted share count of 190 million shares. Moving to the performance of our segments, as you may recall, our Communications Solutions Group, or CSG, was the business most impacted by the wildfire disruption. Total CSG revenue for the first half was $956 million, up 11% over last year, while delivering gross margin of 61.3% and operating margin of 19.3%. In Q2, CSG delivered revenue of $536 million, up 27% year-over-year, driven by 5G-related R&D spending across the wireless ecosystem, early investment in next-generation 400-Gig and PAM-4 network test and strong 27% year-over-year growth in our aerospace, defense and government…

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

[Operator Instructions]. The first question comes from the line of Vijay Bhagavath with Deutsche Bank. Your line is open.

Hi. Good afternoon. Great results; would agree with you Ron.

Thank you, Vijay.

Thank you. I would agree with you; good results. A question for you Ron and then a quick one for Neil. For you Ron, you’re seeing order strength. Any comments on visibility of these orders and the pipeline you’re building up, it’s very helpful for us as investors. And then for you, Neil, on the margin line, what are the puts and takes? It came in a bit weaker than expected, maybe so I’d like to get your thoughts on the margin line? Thank you.

Well, first starting off with our overall visibility, we’re very encouraged on two fronts; one, by taking a look at not only the orders that we have but the funnel that we have and then on top of that the backlog that we have built up in the past. No one knows what’s going on in the economic situation but we do believe when you look at our growth rate that we’re doing a very good job of gaining share and leading in positions such as 5G and Automotive. So that looks very good. I also will comment that with Ixia, although we had to invest a lot this past quarter to make sure that we had all the systems in place and consolidating 28 sites and absorptions of roles, I’m very encouraged to see the funnel start that we have in the beginning of this quarter.

With regards to the margin question, I think we were encouraged by the 20% plus operating margin that we put up here in the second quarter as well as the strong incremental that we have on core growth. I think if you look at the puts and takes, obviously there was a bit of an unfavorable mix shift with the relative weakness in ISG, obviously a strong gross margin business while at the same time we were seeing great strength in our core business. I think the other thing is we’ve emphasized in the past the importance of our flexible operating model and the flexible nature of our cost structure. A core component of that is obviously the fact that 100% of our employees have a portion of their pay that fluctuates with business performance. The formula is linked to both organic growth and operating margin both of which were obviously at high levels for Keysight compared to historic averages. And so we did see a significant increase in our variable payouts in the quarter which was expected and it provides an opportunity for our employees to align themselves with our investor base and sharing the upside while at the same time providing us great protection on the downside. At the same time, we’re investing to obviously continue to make sure we maintain a leadership position in core technologies around 5G and Automotive.

Thank you.

Thank you.

The next question comes from the line of Brandon Couillard with Jefferies. Your line is open.

Thanks. Good afternoon.

Hi, Brandon.

Ron, with respect to the Ixia integration issues in the second quarter, how much of those were really factored into guidance and was that more of a revenue or operating expense impact? And any chance you could size the EPS effect relative to your guidance in the quarter? And then secondly on Ixia, I’d be curious to hear how you’re tracking in terms of the revenue synergies relative to your three-year goal of 50 million now that you’re a year into the closing?

Sure. Well, again just to repeat, we invested significant resources obviously to try to bring our systems together because our job was to integrate the businesses and get to the cost and revenue synergies sooner. And in particular, we moved Ixia on to Keysight’s Oracle ERP system. We went ahead and changed or integrated the forecasting processes, procurement processes. We set up customers where we’ve set up over 90 different customers on brand new contracts which we had to negotiate one by one obviously starting with the bigger customers. And we also changed our manufacturing location where we moved contract manufacturers, and on top of that trade and logistics processes change. So all that took a little bit more time than we thought, but we are on track with the cost synergies. We’re also on track with the revenue synergies. A matter of fact, as I had mentioned, we’re seeing a lot of technology sharing and we saw some of that just come to fruition, for instance, with the Anite acquisition that Satish has been working on in CSG. And we’re at the beginning elements of that seeing that start to work also in Ixia as we just had our Keysight Technical Conference, the biggest conference that we have every two years, and we brought Ixia and the Keysight classic folks together to do that. So we still feel very confident in the revenue synergies as well as the cost synergies, and I’ll let Neil talk to the overall model.

Yes, just relative to guidance, again I would say that it’s really a story of some puts and takes, right. On the positive side, we were expecting the shipment recovery from the fire disruption to carry into Q3. We were able to accelerate that and obviously pull those shipments into second quarter. That coupled with the order strength in the core, the third consecutive quarter of double digit order growth in the core, we’re obviously net positive even relative to the guidance that we put out. On the flipside, Ixia, we had expected some softness and some slowing of the incoming order rate as a result of this significant integration effort, but the ability to ramp sales back did take longer than expected, so there was some downside there relative to what was baked into our guidance.

And I’ll just add one more point with regards to the funnel. The funnel was the highest that it’s ever been inside Keysight for the Ixia business, and it’s been – it’s the highest looking back seven quarters and that’s just as far as we’ve looked back. And April is off to a good start. So that’s what gives us the confidence in our outlook for Ixia.

Thank you. It’s helpful. And then one more for Neil. If you could give us a sense, some ballpark parameters of what the guide implies for 3Q margins? It seems to suggest about a 30% incremental but I suspect Ixia is somewhat of a drag on that relative to your 40% core target for the year?

Yes, we continue to deliver a 40% core incremental into the third quarter and we’ll do so for the full year as well. Obviously in addition to Ixia, we have the Scienlab acquisition. We also have currency which is helping us on the revenue line but is more or less profit neutral. And so you need to take into account the impact of currency when figuring out those incremental.

Thank you.

Thank you, Brandon.

The next question comes from the line of Toshiya Hari with Goldman Sachs. Your line is open.

Thank you so much and congrats on the solid results. You guys raised guidance for the full year. I was hoping you could provide a little bit more color in terms of where you’re seeing the upside? Is it broad based across the entire company or are you seeing the upside kind of focused in one or two specific areas?

I’ll turn this over to Mark Wallace, our leader of sales. But as you can see from our results, we saw strong double-digit growth in three of our four main businesses. So that makes us feel very good. Now obviously aerospace, defense was very solid as well as commercial communications in the Communications Solutions Group as well as looking at total EISG and looking at total SSG. But Mark, why don’t you give a little more commentary please.

Sure. Yes, it really follows what Ron just said. Strong order results across all geographies and segments as we already know in the third quarter in a row of double digit core order growth. I see continued strengths in 5G across both wireless and networks especially picking up in the second half with some of the deployment from the network operators that have already been announced. Aerospace, defense is seasonally stronger for us in the second half and with the U.S. budget being signed, we’re expecting to start seeing some of that funding flowing probably toward the fourth quarter for us. And then our growth strategy around Automotive and energy continues to yield great results six quarters in a row of double-digit order growth. As Ron mentioned in his opening comments, the Scienlab acquisition is really an important and strategic one for us as we move into other parts of the business, including the OEMs. So it really is broad based across all regions and it really is aligned with the focus we’ve put around our growth initiatives.

Great. And then as a follow up, Ron, I think this one’s for you. Obviously the political landscape as it relates to the U.S.-China relationship continues to be unstable to say the least. Given your involvement in leading-edge technology, 5G and other forms of wireless technology, could that have implications for your business in China or should we not be concerned? Thank you.

Toshiya, that’s a great question. We have a very broad-based business inside of China. So there are aerospace, defense customers but also commercial communications customers, automotive, semiconductor, et cetera. So we have a pretty broad-based business and that makes a really nice structure. We did see as we had reported double-digit growth in China this past quarter. I cannot speak for the political landscape on what will happen there but it is broad based and I believe that they need us as much as we need them. So we’ll hope that that works out fine on the political side, but it is a pretty broad impact that we have all across segments.

This is Mark. Just to add one thing is that we’re engaged deeply with both the Chinese customers as well as the multinational customers in China and these are industry leaders and we are – as Ron mentioned, it’s not just within one segment but multiple segments. And the semiconductor growth, that’s been investing in China over the last couple of years and will continue for the next three or four years, represents a lot of opportunity for us. So I think that diversity is a very important part of the equation as well.

And for most customers a lot of times what – the way that some of these potential issues could play themselves out is it takes a look at where the products are shipped from. And most of our products shipped from overseas, from Penang, Malaysia. So that may or may not have a more subtle impact to any type of sanctions that do come up.

Got it. Thank you so much.

Thank you, Toshiya.

The next question comes from the line of Jim Suva with Citi. Your line is open.

Hi. This is Josh Kehoe on for Jim. Thanks for taking our questions. Can you provide more color on the progress of your auto and energy business and when do you think it could possibly surpass your semiconductor test business as a percentage of revenue, especially considering you noted some weakness in semiconductor test for the quarter? Thanks.

Sure. This is Mark. So as I mentioned earlier, our growth initiative is really well on track, six consecutive quarters of double-digit order growth. And it’s really being fueled by the investments being made and really the raise for autonomous driving, electric hybrid vehicles and connected cars. What we have announced too, we mentioned this at the Investor Day as well as over the last couple of quarters calls, that we’re establishing automotive solution centers in several regions to help further strengthen our customer connectivity in our solution development. The one that was opened in Detroit is up and running and it’s doing very well. We plan to open another center in Shanghai, China soon and we have plans for another one in Japan as well. So this is just a further articulation of the commitment and strategy around automotive. And as I mentioned before, the acquisition of Scienlab has really allowed us to expand our solutions into the battery and charging infrastructure space. We’ve won some business already in Q2 and we expect to see that continue especially as the OEMs invest more heavily in R&D along with the overall supply chain. So I think in general we’re seeing the continued strength. As far as the semiconductor, it really serves all industries. So it’s hard to do a compare there, but it is something we are continuing to be successful in. And as a reminder, we have a pretty diverse portfolio of solutions into semiconductor from nano-positioning tools, to wafer test tools, to general test and measurement products as well as services. So that’s another key area. And again it feeds into all of the other industries that we service as well.

Thank you, Josh.

Your next question comes from the line of Joseph Wolf with Barclays. Your line is open.

Thank you. A couple of questions. You touched on this briefly but I was hoping we can get a better differentiation or distinction if there is one to be made between the acceleration and the strength in the 5G cycle and then the optical cycle which I assume is somewhat adjacent but is also can be different given metro builds and timing and other builds going on in China. So I’m wondering if we can actually look at the optical communications as an area of double-digit growth separate to the 5G or whether you think about them in a combined way and how we could think about that on a product level across the different groups?

Yes, this is Satish here. I’ll take this one, Joe. Very insightful in that 5G is not just a wireless technology. It’s a new way of thinking about the end-to-end experience which is the way we think about how our solutions are offered. So obviously there’s the frontend piece, the wireless piece and 5G with the standards that you’re referencing and that has to work together and therefore having 400G type of technology rollout is crucial and we see that playing out both in date centers and in telecom markets. So specific to our business we’ve invested early in 5G a few years ago, made strategic acquisitions like Anite and it takes a couple of years to start to rollout those platforms. Now these platforms are with customers and you’re starting to see the success 10 straight quarters of double or triple digit growth in our 5G business. With 400G, we have obviously been well positioned with 100G. You probably – if you’ve followed us or heard us on earnings calls talk about the ramp that occurred in 2016 through mid-2017 and since then 100G has really tapered off a little bit as people have started to consume the capacity that’s in place. And we start to now see a buildup in 400G even this quarter with strong orders for 400G in R&D and some early orders for 400G in manufacturing. So we see both these things play out concurrently and synergistically and this is why we manage our portfolio with focusing on all these technology evolutions that gives us a pretty good diversity as things play out.

And that’s one of the great things that we really appreciate about Keysight is that we play on the wireless side and the wired side. We play on the physical side, whether it’s on copper or fiber. We play on the hardware side and the software layers up to the top. So we’re really looking at this overall communications ecosystem and other ecosystems in our markets and that provides diversity for our business and provides more earnings, let’s just say stability for our investors.

Thank you. That was actually very helpful. I guess just another question. When you think about the order pattern in the aerospace and defense, I know that this has come up on a couple of last calls, just in terms of the order strength and I guess pent-up demand or the actual procurement cycles, at least our defense analyst is thinking about this as being upside in terms of a pent-up spending cycle and things coming in ahead of expectations. Is that part or how significant is that or how conservative do you think we should be as we think about that potential given the last three – I guess the strength over the last couple of quarters?

Sure. I’ll take that. This is Mark. So I think the budget being signed back in April has alleviated a bit of that pent-up demand. We had a strong quarter. Again, the third quarter in a row of double-digit order growth and that was before any of the funding really started to flow from this year’s budget. That takes time to work through the appropriation process. So a lot of that was the pent-up demand. But really I think what I look at is the underlying driver for this is the investments that are being made around the world and especially in the U.S. to upgrade technology for information warfare and as well as the continuing shift of the prime contractors to be outsourcing more of this work. So the strong demand from the U.S. government and contractors as the budget moves its way through that process, we’ll start to see some of that upside occur again towards the end of the U.S. government’s fiscal year. And again, the encouraging thing is we see strengths outside the U.S. as well, again, around the same things; investments in solutions for EW, information warfare, radar and et cetera. So I would say it’s more about that than pent-up demand which I think has more sustainability to it over a longer period of time.

Excellent. Thank you.

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

Good afternoon. I wondered to know if you could speak just briefly on Ixia. It sounds like you did account for perhaps some revenue disruption but the revenue there did come in lighter than we were expecting. I was just curious as you think about the second half guidance that you updated, do you assume any revenue catch-up with Ixia in that guidance?

You’re correct. We had obviously taken into account the impact of the integration, investments and effort that we were going on. The ramp back to volume took longer than expected. And so we did have lower revenues here in the second quarter than was baked into our original guide. As we look forward, as Ron has already mentioned, we have a very strong funnel entering the quarter. We have many of the issues that we run into are now behind us. The business is ramping back towards normal. I would say we’re cautiously optimistic as we look forward to Q3 that things will return to more normal kinds of levels. I think as you look at Q3 or at kind of the gap in revenue in Q2, some of that will be lost and there’s some potential that some of that will be recovered.

Okay. Thanks for that. And then just with respect to your commentary around 5G, some deployments perhaps starting in the second half of the year. As we think about moving from some of the R&D products now towards deployment, could you just speak to how you think the business – how we should think about that business just in terms of margins, how we should think about in terms of maybe revenue recognition cycles, whether there’s any difference there just as we start to make a transition? I realize it’s still early but you’re starting to see some transition.

Yes, a good question. I think as you have pointed out about – according to GSA, about 14 operators in 11 countries have made some type of announcements around 5G deployments starting 2018. So whether you believe it’s late 2018 or early 2019, that’s a pretty significant number. When you compound that with 48 operators in 33 countries that have announced plans for 5G, it’s pretty clear that this industry is accelerating this technology, again, a trend that we saw and plan for quite some time ago. Our focus is on higher value-added parts of the market, early R&D and our contributions are increasingly for software which should give us better margin profile and Neil will probably pick up on that. But at the end of the day, for us it’s about offering our customers an advantage and we do that by offering end-to-end solutions. We provide a single stop shop now with our ability to have not only the physical layer tools but also go higher on the software stack. And with Ixia we now have the total solution for the entire ecosystem and we feel good about where we are in that 5G journey. In terms of the lifecycle, you’re correct that we’re still in the early phases. Our customers are still in the first vintage of products that are used in trials. Next will be continued R&D investments for the next couple of years in order for them to satisfy the need of the operators that I just referenced.

I’ll just add a couple more points. With regard to our margins, we are committed to the 40% incremental. And although we could go higher than that, we want to make sure that we stay on the leading edge. That is the secret and the key to this business and we’re going to continue to invest while providing the shareholders with the type of returns that we have discussed. There is no doubt that we more software is being entered into the mix of our products with higher gross margins, but then again we have services which are also ramping and we had a record quarter for services which have lower than average gross margins. But overall we’re focused on the customers, making them successful, providing end-to-end solutions, a little bit more software in services and delivering a 40% incremental. Thank you, Rob.

The next question comes from the line of Farhan Ahmad with Credit Suisse. Your line is open.

Hi. Thanks for taking my question and congrats on the great set of results. My first question is regarding the strong growth that you are seeing this year. If I look at the first two quarters, it is above 10% in the core business, excluding Ixia, which is far above what you have guided your long-term growth in the business to be. So in regards to cyclicality, is there a concern here that we might be getting overheated? And as we look into 2019, the growth may decelerate meaningfully from what might be tough compares.

So this is Mark. No, there’s really – there’s no indication that we’re seeing any sort of cycle. As Ron already mentioned, our funnel for our Ixia products is very strong. The same is true on the core products as well. So we’re continuing to build momentum. And the exciting thing is now we’re seeing growth in other parts of our business as well, including software and services. We introduced PathWave and we’ve gotten our first order for PathWave Analytics. That’s a brand new platform. That didn’t exist before Q2. So this is going into a new set of customers with contract manufacturers and ODMs and we’re going to continue to build on that going forward. So I think the investment cycles that we’re seeing with the early R&D and 5G with the early stages of what’s happening with automotive as well as other technologies that are feeding into the connectivity across the world are going to continue to give us opportunities beyond FY '18.

Got it. And then specific to the services group, can you talk about what specifically is driving the strength there? Because I would imagine that that portion of the business is somewhat less variable. And we are seeing more than 10% growth in the first half of this year. So can you talk about why are we seeing the acceleration in the services in such a meaningful way?

Sure. I’ll talk to about a few parts of it. Again, it was a record high quarter for us with services. And then if you look at the components of our services business, really all of them were up at the same time. Our calibration revenues were up. A lot of that growth was driven from our Liberty Calibration labs that was part of an acquisition that we had last year. So that’s doing very well. Repair was up. Our professional services were up. And a lot of the professional services are tied to our equipment sales as we provide start-up assistance for more and more of our customers as they deploy more complex solutions. So there’s a close tie there. And as has been the case for some time, our remarketed solutions continue to be very strong. We have the right mix of inventory and we’re seeing continued demand from some of the same end user segments such as wireless for our remarketed solutions. The last thing I’ll mention here too which is the strength that we’re seeing today from the solutions and product sales should help us fuel services sales in the next year to two years. So that’s also an encouraging part of having services growth now and then going into the future.

And obviously as we see longer-term contracts, this will help us to provide a greater annuity to provide more dampening on the bottom line.

Got it. Thank you. That’s all I had.

Thank you, Farhan.

Thank you. That does conclude our question-and-answer session for today. I would now like to turn the conference back over to Jason Kary for any closing comments.

Thank you, Shawntelle, and thank you all for joining us today. We look forward to seeing many of you at the upcoming conferences. Have a great day.

This concludes our conference call. You may now disconnect.