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.

Thank you, and welcome, everyone, to Keysight's first 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 the Financial Information and Quarterly Reports. Today's comments 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 and encourage you to review our recent SEC filings for a more complete view of these risks and other factors. Lastly, management is scheduled to participate in upcoming investor conferences, hosted by Susquehanna and Morgan Stanley. And now, I will turn the call over to Satish.

Good afternoon, everyone, and thank you for joining us today. My comments will focus on three key headlines: First, Keysight delivered revenue of $1.3 billion and earnings per share of $1.63, both of which exceeded the high-end of our guidance. Given the current market conditions, these results reflect the Keysight team's strong execution and resilience of our financial model. Second, orders were $1.2 billion as the demand environment remains constrained. As certain markets continue to normalize from post-pandemic spending levels, our aerospace, defense and government, and network and data center businesses grew, highlighting the benefit of our diverse end-market exposure. Customer engagement and collaborations on next-generation themes remained strong. The adoption of new use cases such as AI is driving new activity and investment across the ecosystem. However, we're not factoring in a strong recovery this fiscal year. Our base-case scenario is for a modest first-half to second-half improvement in orders and revenue. Third, Keysight continues to be well-positioned for outperformance into a market recovery. We are investing to enhance our market leadership and expand our broad portfolio of leading solutions. We are also pleased to have completed the acquisition of ESI ahead of schedule and extend a warm welcome to the team. Along with our existing EDA business, the addition of ESI further expands our software solutions for simulation and emulation, a market with favorable growth attributes as the virtualization of design and prototyping increases. Now, let's begin with a brief overview of Keysight's first quarter performance. Market conditions were largely unchanged from the prior quarter. Across our end markets, investment in R&D remained steady, while manufacturing and overall economic activity in Asia continued to moderate. First quarter orders were $1.2 billion, revenue $1.3 billion, and earnings per share of $1.63 were above our guidance, and we generated strong…

Thank you, Satish, and hello, everyone. First quarter revenue of $1.259 billion was just above the high end of our guidance range and down 9%, or 14% on a core basis. Orders of $1.220 billion declined 6%, or 12% on a core basis. We ended the quarter with $2.3 billion in backlog. Looking at our operational results for Q1, we reported record gross margin of 67%, an increase of 200 basis points year-over-year. Excluding ESI, gross margin was a near-record 66% on lower revenue, supported by a solid mix of software and higher-value solutions. In addition, software was 22% of revenue, while recurring revenue from both software and services grew 10%. Operating expenses of $491 million were flat year-over-year even with the addition of ESI, demonstrating the flexibility of our cost structure and the cost actions that we have taken. Q1 operating margin was 28%, or 27% excluding ESI. These results demonstrate the financial flexibility and resilience of our business. We are outperforming the financial model that we put in place over a decade ago, which calls for only a 300 basis point to 400 basis point year-over-year decline in operating margin when revenue declines 10%. Turning to earnings. We achieved $286 million of net income and delivered earnings of $1.63 per share, of which ESI contributed $0.09. Our weighted average share count for the quarter was 176 million shares. Moving to the performance of our segments. Our Communications Solutions Group generated revenue of $839 million, down 11%, or 12% on a core basis. Commercial communications revenue of $544 million declined 14%, while aerospace, defense and government revenue of $295 million was down 5%. Altogether, CSG delivered a record gross margin of 68%, and operating margin of 27%. The Electronic Industrial Solutions Group generated revenue of $420 million, down 5%…

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

Absolutely. [Operator Instructions] The first question is from the line of Samik Chatterjee with JPMorgan. You may proceed.

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.

Yeah. Hi, Samik. I would just say that, as we stated in our prepared remarks, right now, we are -- our base case does not include a meaningful second-half recovery. We're really more looking at seasonal changes as you move throughout the fiscal year, so flattish Q2 to Q3, and then a typical seasonal uptick into Q4, which is typically our stronger quarter of the year. In aggregate, we do expect orders and revenue in the second half to be modestly above the first half, but we're not baking in a recovery at this point.

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.

Sure.

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.

Yeah. Thank you, Samik. I would say, at the highest level, the customer engagements that we have are remaining strong. And while there are signs of optimism from customers as we enter the new calendar year, we have not yet seen a progression through our pipeline. And as we said in our -- in my prepared remarks, the market conditions remain largely unchanged from a quarter ago. The aerospace, defense strength that we saw last year continues on. And what we have seen incrementally is the wireline business has actually grown for the first time this quarter, and that was a function of some of the AI-related end-market inflections that are occurring. If I take a regional cut at this, I would say, our largest region, Americas, grew for the first time in four quarters, and this is driven by again the strength in aerospace, defense and the wireline business. But Asia continues to remain weak, especially which is impacting the EISG business and some of the wireless business in that region as it continues to normalize from the peak spending levels. Again to put your question in perspective, CSG entered that normalization phase early and EISG was offset by a few quarters. And so that's what's currently playing out. So, given this backdrop, we think it's prudent to think of a base-case assumption where orders and revenue would be up modestly first half to second half. But should there be a broad and stronger recovery sooner, and there may be some signs out there around SIA index where things are picking up, some of the inventory digestion that's happening, capacity utilization, fabs, but should that occur, we will be in a good position to capitalize on that and recover quicker.

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

Yes. Good afternoon. Thanks for taking the questions. Satish, you mentioned I believe double-digit growth in orders to support data center builds for products like high-speed wireline, which you attributed to AI. Can you give us a better sense of how much of either revenue or orders may be directly or indirectly benefiting from AI at this stage, and how you see that progressing?

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.

Yeah. That's a helpful color. My second question was on margins. The company has a target for its EBIT margin to reach 31% to 32% by fiscal '26. Maybe you can help us better understand what kind of revenue would be needed for the company to reach that kind of margin. And I think you have a 5% to 7% revenue CAGR target. I mean, should we be thinking about a couple of years of at least the high-end, if not, higher revenue relative to that targeted order to reach your margin objective? Thanks.

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.

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

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.

Yeah. I think as far as the ESI question goes, I think we're quite positive, incrementally positive about the opportunities that we have to grow our -- grow the ESI business in Keysight's environment. We've long studied the system simulation/emulation marketplace. And so, having all of the capabilities is definitely a huge advantage. And for us, bringing an asset that was sort of locked-in in an European environment and exposing it with our go-to-market channel and taking that into our customer base remains an opportunity to drive growth above what they've been able to do. But incrementally I'm pretty bullish about the technology and the depth of simulation capabilities they bring. They also have a hybrid AI capability that is pretty unique and differentiated that we'll look to fully leverage across the company as we go, and we're also positive about the strong start in the first quarter for ESI. And I'll just hand it off to Mark to make some comments on the pipeline that he sees and how he sees that progressing.

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.

Great. Thanks so much.

Thank you.

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

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.

Yeah. I mean I think areas of relative weakness, Satish talked about Asia and China specifically continues to be challenging. I think manufacturing continues to be challenging. And I think we see our wireless customers that are still working through some other issues. On the positive side, wireline, driven by AI is clearly a strength point. Mark, do you want to add?

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.

Thank you. Appreciate that. And then, for my follow-up, I wanted to ask around backlog. Neil, I think you said $2.3 billion again, which is more than six months of coverage at this quarterly revenue run rate. But you guys are kind of saying that you don't expect revenue to get better into the back half of the year. So, on this excess backlog, when does the company think it could start coming through in revenue? And is it because these big chip customers are pushing out their CapEx plans, or is it just because of the company has moved more towards a solutions-based model? Any help with that would be great. Thank you.

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.

Thank you. The next question is from Adam Thalhimer with Thompson Davis. Your line is open.

Hey, good afternoon, guys.

Hi, Adam.

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?

No. I think that's basically -- we are performing in line with the model, right? So, if you take a look at what's happening, obviously, you see the significant sequential decline in ESI, which is as expected. But if you adjust for that, you're seeing a mid-teens kind of decline in the core business, right, from a revenue perspective. And we've talked about the downside model that contemplates 300 basis points to 400 basis points of operating margin decline when revenues are down 10%. Obviously, we're down significantly more than that, but we're continuing to perform basically in line with that model. We've taken significant actions. Our cost actions started last year and enabled us to deliver record operating margins on flat revenue in an inflationary environment. And then, this quarter, as it started to begin to appear that the recovery was pushing out, we've taken incremental actions that are going to benefit us. We now expect that total OpEx for the company will be down low-single digits on a year-over-year basis prior to the addition of ESI. And all of that reduction is going to show up in the SG&A line items as we like to strike a balance between investment and financial performance. We're going to maintain our investments in R&D. We would expect R&D to be flat. But again, total OpEx down about 3%, driven by actions we've taken to control SG&A.

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

Yeah, Adam, in the quarter, we saw continued R&D spend for battery and charging infrastructure. We expect that to continue. Manufacturing spend, supply chain spend was down. You've seen unit volumes drop for both conventional and EV demand. So that's where we see that. But e-mobility, which is EV and autonomous, as Neil mentioned, as I mentioned, the funnel remains strong, very robust, as we look at Q2 into FY '24. A lot of this is a long-dated program spend around battery test charging infrastructure. Some of these products -- programs are fluid. So many of them are based on some government subsidies that you may have read have been delayed in Europe and so forth. But we're tied into all of those. And as we look forward, this space continues to be one that's going to be driving growth for us for a long time.

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.

Thank you. The next question is from Tim Long with Barclays. Your line is open.

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.

Yeah, we'll do. Tim, I think at the highest level, what we've seen so far is that Release 15 and 16 deployments that have occurred largely in the United States and in China and now in India. So, we expected, and we've talked about this to the industry capital, would peak some point in '22-'23. So roughly we got that timing right. But if you think about the business model that we established for commercial comms and for our wireless business, it was always about more vector to service the R&D customers. So, while even in this environment, the volumes are down especially the manufacturing production-related volumes with the RAN markets down. So, we're starting to see that effect and the businesses normalizing. But what we're continuing to see is customers engage with us in buying upgrades for their release library. So going from 15, 16 to 17 as an example, which is much more evolutionary nature. But as we think about the future now, the roadmap is very clear. It's sort of a roadmap for the next five years where the industry is working on Release 18, Release 19 followed by 20, which would include some early study items on 6G as an example. But some of the same ideas that we had for growth, which are built around vertical industry expansions with AI ML, new device form factors such as the Vision Pro that's just launched that's capturing a lot of imagination on what augmented reality can mean in the future. And just sort of the integration I should say of satellite communications and terrestrial networks is opening up new threads of innovation and exposing us to more customers that want our capability. So all-in-all, in balance, I look at the capabilities we have, our market leadership position that we've established in 5G, and I feel confident that post-normalization of this demand that we can return the business to growth even prior to 6G. But that's yet to play out, but that's our best thinking at this point.

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.

Yeah. I think, what we're seeing is obviously, the first instantiation with every technology like this, where 100 gig times 400 gig times eight sort of topologies are currently being -- are being deployed. And so, we're obviously, engaged with that and we're starting to benefit from that. But the roadmap is clear, right, then it's going to get to 200 times four, because the scaling continues and leading to even higher-speed research in 1.6 terabits and beyond. So that's on the wireline side. The Ixia business or what was Ixia business, we -- it's integrated into our wireline business and it's been remarkably stable for us in the commercial communications market because of the higher services and software content associated with that business. And it's also a business that doesn't really trend up that significantly during upcycles. So, it's been a very steady business for us. And one we're -- now we're able to take out some of the traffic generation capabilities and adapt it to go address some of the emerging AI use cases. So, we're quite pleased by the assets we have in the company and by our ability to go and solve customers' emerging challenges even beyond the traditional segments we serve.

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

Yeah. Thanks for taking the questions. I have two as well. Neil, I wanted to go back to your prior comments on kind of backlog. I know last quarter -- last couple of quarters, you've talked about these longer-dated backlog or order dynamics, and I think even last quarter you quantified it at like $400 million. Can you give us an update how much of your backlog today is kind of these longer-dated deals? And could we consider them as kind of large lumpy deals that possibly rev rec wise show up late this year into more so '25? Or how do we just think about that?

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.

Yeah, that's helpful, Neil. And then, as a second question, I wanted to go back to the AI networking discussion. Clearly, a lot of focus here, but a lot of focus on the wireline side is this 400-gig, 800-gig transition towards Ethernet versus InfiniBand. I'm curious to Keysight's positioning. Is there a disproportionate position around Ethernet and the deployment cycle of back-end AI networks based on Ethernet versus InfiniBand? Or is it maybe not such that we should delineate between the two for the company?

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.

Thank you. The next question is from Matt Niknam with Deutsche Bank. You may proceed.

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.

Yeah. I'll take the second part, then I'll have Mark sort of walk through his thinking on the pipeline, which really no impact -- I mean, which really flow into our guide, if you will. On the wireless side, I think we're continuing to expect stability and moderation as it comes off of strong peak demand years in '21 and '22. So that normalization phase continues to play out over the next couple of quarters, and that's sort of our base case thinking on wireless. All of the R&D activity that I described continues on, but we're still waiting for any inflection in component spend which we're not seeing at this point. So that's sort of our expectations on wireless. And I'll just have Mark make some comments on the pipeline.

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.

Great. Thank you.

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

Yes. Thanks for taking my question. First one is for Neil. Just want to better understand the organic change in your revenue. Assuming $60 million from ESI in the January quarter and then about $25 million in the April quarter, the decline in organic revenue on a sequential basis is only 2%. Is that correct?

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%.

Sure. So perhaps maybe the expectation was for a different contribution from ESI and maybe a little bit better than expected trend with the organic. But the ESI is making some compares difficult. Would you agree?

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.

Right. Okay. Don't want to come across [indiscernible], but I think these compares get a little bit murky looking into April versus January. Looking into July and October, obviously, your comments suggest maybe April, July will be the bottom and then a modest recovery in October. So the question for Satish is what do you think the driver behind that modest rebound would be? And why should we assume acceleration in that rebound into FY '25? The 5G is behind us, but what are some of the other key drivers that would give you confidence that the modest rebound should follow by acceleration unless you tell me it's just going to be a modest improvement into FY '25?

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.

Got it. Thank you.

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

One of the hallmarks of Keysight has been the ability to continue to invest organically and inorganically through cycles. How do you see R&D spending and also your appetite for additional M&A this year?

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.

And I could add -- just add one additional bit of color on the R&D side. We stayed very disciplined in the period of time in '21 and '22, where revenues were growing at a high level of rate. We underspent our R&D target of 16.5% of revenue that continued into '23. What that enables us to do now in '24 is maintain R&D investments basically flat. As I said in my earlier comments, that'll take R&D up above that 16.5% target on a percent of revenue basis, but it'll allow us to continue our investments to make sure that we're full participants in the eventual upturn.

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?

Yeah, I think ESI was well on track of transforming the business to growth. And our first priority is to continue to support their base plan. And that's baked into '24. But in a targeted way, Mark and his team have already started to engage to take those capabilities and apply them to our aerospace and defense customer base in the U.S. as a first order of priority. But as I've gotten to know that portfolio, what gives me excitement is their core technologies around hybrid AI, which I think could find a broader leverage into other Keysight applications to accelerate our pursuits. But that's with time. Our number one priority is to stabilize, integrate, and basically keep their base plan on track. And I think they're off to a good start.

All right. Thank you very much.

Thank you.

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

Yes, thank you. Neil, I wanted to go back to the conversation you pointed out the operating model performing as expected on the downside operating margin on a year-over-year basis. Is there anything that you'd call out sequentially impacting operating margins? It just looks like the sequential deleverage is a little high, if I'm doing my math correctly, higher.

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.

It might also be worth highlighting our confidence in both the operating cash flow performance and also the free cash flow conversion, we had 98% of net operating profit this quarter. So, we feel good about the cash flow generation capabilities as we navigate this near-term downturn in our markets.

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?

Yeah. I think when we think about the markets, we're approaching it, obviously, from tests to emulation to simulation, and we're connecting the workflow there. In many ways, we collaborate with all of the players that have been on record, and we have a relationship with them so that we can offer a good workflow experience for customers. And this has long been a market where there's been good interplay between the tools because just like Keysight is an engineering company, we are also a customer of a number of these tools, and it's hard to standardize on the tool or the other because each of them have different focus areas and different strategies. So, when we piece it together, we don't view this as necessarily a big impact to our plans. We, in fact, are continuing to progress our system simulation, emulation strategy and SAM expansion. And with ESI in the company, we have more capabilities to drive that strategy moving forward.

Very good. That's helpful. Thank you.

Thank you.

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.

Thanks, Joel, and thanks, everyone, for joining us today. We look forward to talking to you later this quarter and wish you a good day.

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