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.

Thank you and welcome everyone to Keysight’s third quarter earnings conference call for fiscal year 2022. Joining me are Keysight’s President and CEO, Satish Dhanasekaran and our CFO, Neil Dougherty. In the Q&A session, we will be joined by Senior Vice President of Global Sales, Mark Wallace. You can find the press release and information to supplement today’s discussion on our website at investor.keysight.com under the Financial Information tab and Quarterly Reports. Today’s comments by Satish and Neil will refer to non-GAAP financial measures. We will also make reference to core growth, which excludes the impact of currency movements and acquisitions or divestitures completed within the last 12 months. The most directly comparable GAAP financial metrics and reconciliations are on our website and all comparisons are on a year-over-year basis, unless otherwise noted. 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. We assume no obligation to update them. Please review our recent SEC filings for a more complete picture of our risks and other factors. Lastly, management is scheduled to participate in upcoming investor conferences hosted by Jefferies, Deutsche Bank, Citi and Goldman Sachs. We hope to see many of you there. And now, I will turn the call over to Satish.

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…

Thank you, Satish and hello everyone. We delivered strong third quarter results, successfully navigating ongoing supply chain and other headwinds. Third quarter 2022 revenue of $1.376 billion was $26 million above the high end of our guidance range, and grew 10% or 13% on a core basis. We generated $1.461 billion in orders, up 12% or 14% on a core basis, and we ended the quarter with $2.5 billion in backlog. Turning to our operational results for Q3, we reported gross margin of 65%, holding steady in the face of significant inflation and currency headwinds. Operating expenses were $480 million, resulting in an operating margin of 30%. We used a number of strategies to effectively navigate supply chain challenges, including product redesign, alternate sourcing and increased supplier and customer engagement. We achieved net income of $363 million and delivered $2.01 in earnings per share, which was $0.21 above the high end of our guidance. Our weighted average share count for the quarter was 181 million shares. Despite significant currency headwinds on the top line, we saw negligible FX impact to earnings due to the meaningful natural hedge provided by our global footprint that has been supplemented by our financial hedging program. Moving to the performance of our segments, our Communications Solutions Group generated record revenue of $970 million, up 11% or 13% on a core basis. CSG delivered gross margin of 67% and record operating margin of 30%. Within CSG, commercial communications generated record revenue of $694 million, up 17% or 19% on a core basis, driven by 5G, O-RAN, 400 gigabit, 800 gigabit and high-speed digital applications. Aerospace and defense and government revenue of $276 million was down 2% and up 1% on a core basis. Our backlog for this end market remains strong, and we continue to expect…

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

Our first question comes from the line of Jim Suva with Citi. Jim, your line is now open.

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

Thank you, Jim.

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.

Yes, sure, Jim. As you noted, this is one of the new expansion opportunities that we’re incredibly excited about, and we’re continuing to build momentum. And as you saw emerging from the pandemic, this big acceleration into EV and AV has just gotten started. And from a manufacturing perspective, yes, we have some exposure to it, but it is this proliferation of electronics content that’s causing automakers to ramp up production as supply becomes lesser and lesser of an issue over time. So it’s all about testing their EV capabilities in the manufacturing environment. So we have some exposure to that. We are very excited by this big trend we see that’s going to play out over the next 10 years where auto makers are going to increasingly invest in organic R&D capabilities needed to differentiate their platform over others. And that involves software and hardware, and it’s a great fit for the broad array of tools that we offer to every electrical engineer in the planet that we’re now selling into the automakers. But equally, the growing emphasis we have put on – growing our footprint in EV. As an example, this quarter, we had some design wins with some giga factories that are coming up just getting started in the Radar Scene Emulator solution, which really allows you to take a car, turn on all the sensors and really see how we behave in the real world, very unique solution offering. And we had a design win with a major North American car manufacturer. So just getting started, very excited about the opportunity and strong double-digit growth in orders this quarter.

Thank you so much for details and clarification and congratulations.

Thank you, Jim.

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

Hi, guys. This is Nick on for Matt. Congrats on the quarter. Just a quick question and a follow-up. First, on supply chain, I am just curious if you could give us an update in terms of what you’re seeing on the ground right now and maybe how that compares to like a quarter ago or a year ago? And then just as a follow-up, how are you thinking about your long-term targets at this point? I mean looking at order growth and revenue growth, you’re clearly surpassing that. So maybe like when we could expect updates on those?

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.

Alright. Thank you and congrats, again.

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

Hi, team. This is Dave on for Meta. Congrats on the quarter. You mentioned strength within the commercial communications group. And I was just wondering if there are certain categories within that group that are driving the growth. With some of the delays the ecosystem is seeing on O-RAN, are there areas where customers are asking you to be of greater assistance?

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.

Sure. Thanks, Satish. As Satish said, Dave, the 5G rollout and demand continues to be very strong. And our bias toward R&D solutions is an area of investment for all of our customers. We saw double-digit demand and order growth across all regions. One of the drivers is the adoption and upgrades around Release 16. We’re seeing that across the board. We’re seeing adoption now with some of the certification business in the test labs. We added more than 90 new 5G customers again during Q3. We’re seeing continued growth of O-RAN where we’ve been expanding our opportunities from device manufacturers to operators to test labs and etcetera. So wireless side, the demand remains strong and broad. And as Satish said, on the wireline side and the data center side, we continue to see strong investments in the quarter for 400G manufacturing plus continued even ramping investments around 800 gig R&D and on both the physical layer and the protocol space. So robust demand. Our differentiation for many, many years, continues to expand our ability to contribute to these customers around the world.

Great. Thank you.

Thank you. Our next question comes from Chris Snyder with UBS. Chris, your line is now open.

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?

Yes. It is – I mean it is true that we have been undergoing a series of price increases as we attempt to kind of keep place with the inflation that we’re seeing on the cost side of the equation. And it is also true, as we’ve talked about in the past that it can take time for those price increases to actually be realized within revenue given the backlog, given the funnel, given the outstanding quotes that exist within the marketplace. And so it is certainly true that we have price increases that are built into our backlog. I think the second, beg your question is a little bit harder to answer because we don’t know exactly what is forthcoming on the inflation side, right? Whether that continues, whether it starts to wane, but we do expect to start to realize additional benefits from price increases that have already been enacted.

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

Thank you for that. I think on the last earnings call, you guys said that the guidance assumed further backlog build in 2H. Obviously, we got a little bit more backlog built here in the fiscal third quarter. I guess, is the assumption that we will be further backlog build in Q4? I’m just asking because it sounds like from the prepared remarks that some of the supply constraints have been easing.

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.

And the demand environment continues to remain strong, and across our end markets and across all regions. So we continue to build a backlog, but it’s a high-quality backlog where we have touch points with customers and – who have real needs. And so we will be working really hard to get that converted to revenue as we look into the next 6 months.

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?

Yes. We’re quite pleased with the portfolio, the differentiation, the focus on the R&D customer. The areas that we’re investing to build solutions for, continue to remain a high priority for our customers. But we’re also cognizant of the macro environment and the evolving macro, and watching for it. As an example, one of the areas we look for is in our industrial business, which is linked to PMI. But that business had a very strong quarter yet again. But Mark may be able to make some forward-looking comments on the funnel.

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.

Thank you, guys. Congrats on another great quarter.

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

Yes. Thanks for taking my question. This is for the entire team. Keysight has been known for having exposure to both R&D budgets as well as commercial deployment. Would it make sense to change that thought process, and actually qualitatively or quantitatively talk about secular demand drivers like satellite communication, millimeter wave, infrastructure investment, electric vehicle and so forth? So this way, we could better understand the underlying demand drivers. Any thoughts would be appreciated. And I have a follow-up.

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.

Yes. I think we all understand how Keysight is differentiated and how well you have executed, especially with all the supply chain disruption over the past 2 years. And as much as Neil has been talking about the normalization of the backlog, it continues to grow, which reflects your core strength. I guess we are all trying to figure out what’s the company’s earning power and sustainability of that earning, $8 going to $10 and then to $12. I think the thought process of the past that 5G would pick is off the table. And I guess I am trying to find a better way to highlight the opportunities as well as quantifying the earning power.

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.

Got it. Thank you and congrats.

Thank you, Mehdi.

Thank you. Our next question comes from Mark Delaney with Goldman Sachs. Mark, your line is now open.

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.

Sure. Mark, this is Mark. I will answer that. So, our business in semi remains very strong, robust demand, record orders in . And what we are seeing, and we have said this before is we are seeing continued investments in tow areas, right. One is in the advanced processes and the other is in the mature technologies, and both remained strong during the quarter. The other exciting part is we are starting to see the investments in the United States in new fabs. We have started to – we captured the first initial spend. You saw earlier this month, or maybe this last week, the U.S. Congress just passed the CHIPS package that’s all in front of us. That expansion is going to help additional business, fuel additional growth to boost manufacturing in the U.S. And our R&D investments, it’s not just capacity expansion. We are also participating in parametric test as well as R&D test in these advanced processes from EUV to 5-nanometer, 3-nanometer. So, while some end market demand has slowed, there is still supply chain constraints in the semiconductor market. And the longer-term secular growth drivers are still strong driven by end markets like high-performance computing, automotive, we talked about and new mobility and silicon photonics where we have a leadership position feeding into high-speed data centers and so forth is an area we are very excited about as well.

Thank you.

Thank you. Our next question comes from Adam Thalhimer with Thompson Davis. Adam, your line is now open.

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?

Yes. I think it’s an area where historically, we were in the component test of the satellite ecosystem. That has been an area of strength for us and where we are highly differentiated and some of the unique metrology components do get into for – to calibrate some of the more complex measurements in that space. What we are seeing now as we look forward is new applications like non-terrestrial networks with the advent of 5G, and this proliferation of different satellite form factors and communication with ground stations, right. So, we are getting into emulating the whole environment so that we are designing better for the crowded satellite and space environment that’s ensuing. But we are very pleased with the uptick we are seeing in the business for the entire portfolio because the number of customers that are in this industry also is expanding beyond the few big ones we used to have in the past. So, pleased with the growth in the business. It will continue to be a driver for our aerospace and defense business moving forward.

Got it. Thank you.

Thank you. Our next question comes from Rob Mason with Baird. Rob, your line is now open.

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?

Yes. I think if you look at the PathWave effort that we have put in place for a few years now, it’s really focused around building the organizational capabilities needed because the future of our industry is going to be software-centric. And so we have built capabilities, such as cloud that has enabled us to launch the O-RAN solution where we are now able to test virtualized network infrastructure. And the only way you do it is you have to have your assets on the cloud, and that’s a critical component of how we deliver value through PathWave. The PathWave design franchise that we have had continues to grow. We have been able to convert majority of the customer base into recurring subscription-based contracts, and we are moving that franchise from just being able to simulate circuits to simulate circuits in complex environments. And that’s a new area of emphasis that will continue to grow. And on our base instruments, it still remains a focus for us to add more capabilities, connect them to the cloud so that we make our customers more productive in their labs, and that’s the focus for us moving forward. Bottom line is we are at 20% of our mix, roughly software. And the focus for us is to continue to grow that, and we will continue to invest in more software capabilities to do it. Mark, I don’t know if you had any other…

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?

Yes. I mean it’s – the conversion of orders to revenue is definitely a supply chain issue. I mean as we indicated in our prepared remarks, we are starting to see the flow-through of the budget was appropriated in late spring. And so we are optimistic as we look forward into Q4, and even into Q1 that that’s going to continue to drive growth. We are also seeing increased defense budgets in Europe and Japan, which is also additive. But as you start to think about converting that over, we are still very much supply constrained across the portfolio. And while we have seen some improvement in certain aspects of the supply chain within the quarter, we are still in that constrained environment. So, yes.

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.

Understand. Thank you.

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

Thank you for taking my question. The U.S. CHIPS Act also included about $1.5 billion dedicated to O-RAN, and there was sort of similar funding in the UK government as well. So, I just wanted to check in, any indication sort of the level of orders to-date for Keysight in the O-RAN space? How meaningful is that? And what do you think the impact of this kind of public funding that’s going to start flowing there will be?

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.

Thank you. And then a quick follow-up here, you cited gross margin performance a couple of times. Just to help us think about pricing. Should we think about historical Keysight pricing kind of in a low-single digit range, and that you have moved up into a mid-single digit range. Is that kind of the order of magnitude around pricing? Thank you.

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.

Okay. Thank you very much.

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.

Thank you, Amber and thank you everyone for joining us today. We appreciate the opportunity to provide you with an update and look forward to speaking with many of you later this quarter. So, thank you and that’s all for today.

This concludes our conference call. You may now disconnect.