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

Thank you, and welcome, everyone, to Keysight's third 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 discussions are on our website at investor.keysight.com under 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 Jefferies, Deutsche Bank, Citi and Goldman Sachs. 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 executed well by delivering revenue and earnings above the high end of our guidance in market conditions that were stable and consistent with our expectations. Second, orders of $1.25 billion was slightly above expectations and in line with prior year and growing low-single-digits sequentially. In a mixed demand environment, we continue to see stability and pockets of growth, particularly in commercial communications. The funnel of opportunities supports our outlook for second half orders to be above first-half orders followed by a more gradual recovery in 2025, barring any further macroeconomic degradation. Third, we remain confident in the strength of our business model and are intently focused on value creation for both customers and our shareholders. Our capital allocation priorities have not changed. First, we're strategically investing to deliver leading-edge capabilities as new technologies inflect and to return the company to our long-term growth trajectory. Second, we're expanding our SAM and growth opportunities through disciplined M&A. And third, we are committed to returning capital through share repurchases. In fact, we returned over $715 million or 78% of free cash flow over the past four quarters. Now let's begin with a brief overview of Keysight's third quarter performance. Revenue of $1.2 billion and earnings per share of $1.57, above our expectations. And for the second consecutive quarter, we saw relative stability in both orders and revenue. Turning to our business segments. CSG returned to order growth in Q3. While revenue declined 8% year-over-year, we saw some modest improvement sequentially. Commercial Communications orders grew low-double-digits. Strong growth in wireline driven by AI, more than offset the year-over-year decline in a sequentially stable wireless business. Wireline orders grew for a third consecutive quarter, driven…

Thank you, Satish, and hello, everyone. Third quarter revenue of $1.217 billion was above the high end of our guidance range and down 12% or 13% on a core basis. Orders of $1.249 billion were essentially flat or down 1% on a core basis. Backlog at the end of the quarter grew $30 million to finish at $2.3 billion. Looking at our operational results for Q3, we reported gross margin of 64%. Operating expenses of $484 million, were up 1% year-over-year. Excluding acquisitions, SG&A expenses were down 7%, reflecting our cost flexibility and actions taken to-date. Q3 operating margin was 24% or 26% on a core basis. Year-to-date, core operating margin is down only 400 basis points, continuing to outperform Keysight's down cycle model and demonstrating the financial resiliency of the business. During the quarter, we amended our tax returns from 2020 onward to reflect an amortization deduction related to a prior period corporate restructuring. This change reduces our effective non-GAAP tax rate from 17% to 14% or 300 basis points for fiscal year 2024 and going forward. Turning to earnings. We achieved $275 million of net income and delivered earnings of $1.41 per share, excluding the impact of the tax rate change. This tax change added an additional $0.16 to earnings per share, of which $0.11 relates to the first-half of FY '24 and $0.05 to Q3. All in, we finished the quarter at $1.57 in earnings per share. Our weighted average share count for the quarter was 175 million shares. Moving to the performance of our segments. The Communications Solutions Group generated revenue of $847 million, down 8% on both a reported and core basis. Commercial communications revenue of $572 million, declined 6%. While aerospace defense and government revenue of $275 million, was down 10%. Altogether, CSG delivered…

Thank you, Neil. Sierra, could you proceed with the instructions for the Q&A?

Definitely. [Operator Instructions] Our first question comes from the line of Mark Delaney with Goldman Sachs. Your line is now open.

Yes. Good afternoon, and thanks very much for taking my questions. Orders were up slightly both sequentially and year-on-year after being down year-on-year for the prior six quarters. Maybe you can help us better understand how meaningful you think the pickup in orders is as a sign that the cyclical environment may be changing?

Yes, hi Mark, thanks for the question. Obviously, we're encouraged by the continued stability that we see in our base business inflections that are material in our wireline business, some signs of rebound in semi, although it's too early to call it. So -- and then there's some incremental weakness in the automotive sector. So we put it all in the blender, and say, in this current environment, we're encouraged by this returning to slight year-over-year growth as we've seen, but it might be too soon to call a recovery at this time. And the key point is we're executing well, and we feel good about the -- our own portfolio and its differentiation and the investments we have made to continue to keep that going.

Thanks for that Satish. My other question was a follow-up on the orders. You mentioned AI as a positive contributor yet again to commercial communications. Maybe you can help us better understand what percentage of commercial communications orders are tied to AI at this point? And how impactful might AI be for revenue within commercial comms as you look out over the next 12 months or so? Thank you.

Thanks, Mark. Yes, we're quite pleased that commercial communications orders grew double-digits this quarter. Again, as I mentioned, we have a pretty diverse portfolio that caters to the entire communication cycle system with solutions. So you can think of wireless and wireline and the wireline ecosystem represents roughly about 40% to 45% of our commercial communications business, and it's inflecting driven by the AI spend. Now when you think about how big could be longer term, I think the answer is becoming quite clear that AI is going to be a pretty transformational technology that's going to lead to evolutions of multiple underlying waves of standards and technologies, but it's not yet played out. Today, the state of the affairs is it's a highly concentrated opportunity set driven by the big investments made by the hyperscalers. And it is a constricted sort of constraint, I should say, sort of environment from a supply perspective. So there are some challenges that the customers are working through. So we're seeing, and we're picking up some of that capital investments that are playing out through our manufacturing business that is rapidly expanding. But equally, we're making good progress, I would say, in engaging with standardization across the entire stack and in making meaningful contributions in R&D across compute, power and thermal, networking protocols and memory, all aspects of innovation that customers are playing into. But again, the ecosystem, I believe, will broaden over time. And our goal has been for the last 18 months to nest this opportunity, feel good about our market position.

Thank you.

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

Yes. Thanks for taking the question -- questions. I want to go back, it's been a little while, but at the Analyst Day a little over a year ago, you had outlined a revenue CAGR of 5% to 7%. And I'm curious as we kind of see the stabilization of orders, we think about the return of growth here. Is there anything that's changed as we start to think about the next fiscal year that you would put out there for us to think about relative to that 5% to 7% growth rate. And if so, I mean, why wouldn't we expect even a stronger growth rate just given the easy comps that you're looking at?

Yes. Thank you, Aaron. Obviously, our long-term view of the opportunities and the underlying drivers remain unchanged. And so we would expect the business to trend back to those levels. That's point number one. However, look, '21 and '22 have been outsized years for our markets, and '23 was a flat year, flattish year. We continue to deliver value in '24 is a down year for the market. And so our first priority is to say that we can -- the business conditions have stabilized. That was our sort of first milestone, I should say. And as a sign of that, we feel good about what we had shared with you last quarter, which is that the second half orders would be greater than the first half, okay? So that's the first thing. Second is the shape of the recovery, as we've seen, it's still a pretty mixed environment. And we're not, at this point, factoring in an in-phase recovery, if you will, across all our multiple end markets. And therefore, we would, at this point, say we're thinking about this as a slow gradual recovery in 2025. However, the actions that we're taking in terms of things we control, our innovations, engagements with customers are all with an intent to maximize. And I feel good about Keysight's position. Obviously, we want to see some more progression in the funnel dynamics, which are trending positive, but you'll hear more from Mark later we want to see that progress a bit more before we can talk about what those growth rates might be for '25.

Yes. Very helpful. And then just as a quick follow-up. I'm curious, as you -- Neil, I think a quarter or two ago, you talked about longer-dated backlog build or orders. I'm curious, any update on that and what you're seeing in the market today.

Yes. The incoming order rate range reasonably stable in the upper single-digits level of mix. And on the revenue side, we are trending in that direction. We're not yet to the point where the revenues are at that level. But in the next quarter or two, we'd expect to achieve that.

Yes, thank you.

Thank you.

Our next question comes from Matt Nickman with Deutsche Bank. Your line is now open.

Hey guys. Thanks for taking the question. This is Michael Allen on for Matt Niknam. I was just wondering if you could make a little more dig a little more to the aerospace, the ADG segment. Is -- or are these delays just kind of pushing more into the next quarter? Or is this kind of a slowdown of when you expect to see more of a year-over-year growth rate? Or just any more color on that.

Yes. Thank you. I'd say the older arching trends given the geopolitics that we're under are positive, so that's number one. There is bipartisan support for budgets in defense in the United States and increasing support for raising budgets around the world. Japan just announced an increase and Europe is also focused on that. And I feel good about Keysights focus -- long-term focus we've had in defense modernization with Quantum solutions with solutions for ultra-magnetic spectrum operations, space and satellite. They're all aligned with the right priorities. Having said that, the budgets and appropriation timing does have an impact really hard to predict on a quarterly basis. But we like the pipeline that's building. The prime contractors increases are also something we monitor in the U.S., and we feel good that those will all eventually flush into orders for us. This year, obviously, we're lapping a full year of 2023 of record levels for order and revenue for the aerospace and defense business. So you'll see some -- the revenue levels are down. And to the point about the long-dated backlog, we have won some large systems businesses last year and this year, which will also convert into revenue next year. So I would say that the drivers have remained intact. Our position remains solid and the pipeline is strong. Thank you.

Awesome, thank you.

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

Just on automotive. I mean, I think the broader weakness in the EV market is well known. But I saw you mentioned clients delaying projects. Are they looking to kind of restart maybe at the beginning of calendar 2025. just sort of gain a sense of the tone in those customer conversations.

Yes, David, this is Mark. It's hard to predict when the timing is for some of these projects. Some of them have very long processes associated with the procurement process, including proof of concepts. And then the projects themselves last many quarters, it falls into this category of some of the long-dated business that we've been talking about for quite a while. What I think we are seeing though is the continuous focus on innovation with our key automotive customers, the AV side and software-defined vehicles that is now migrating toward continued to show growth in the quarter sequentially. We are continuing to work with customers in all regions. So this is a global situation that we are well positioned for. And what I would look for in 2025 is some of the moderation of the slowness that we've experienced for many quarters around manufacturing as capacities are required to increase. And then I think given the regulatory situation, the political climate and the long-term commitments to e-mobility, I would expect the pause that we're seeing right now in some of these battery test and EV projects to begin gaining some momentum in the next several quarters.

Understood. And then a quick one for Neil. Just to check, when you said 14% tax rate going forward, that's a good baseline modeling assumption for next fiscal year?

Yes. For next year, we actually would expect it to that tax rate to hold for multiple years. The next thing that we're aware of is the U.S. GILTI tax rate, that's a tax on offshore profitability is scheduled to increase in 2027. So we'll need to evaluate the impact of that on Keysight once we get closer to that implementation date. And then the only other thing I would add is both of the current presidential candidates have prioritized tax legislation for the first year of new administration. Obviously, we don't have any way to assess what those programs would be like and so this doesn't account for anything that could be passed as part of a new presidential administration. But the status quo through '27.

Got it. Thank you very much.

Our next question comes from Meta Marshall with Morgan Stanley. Your line is now open.

Great, thanks. A couple of questions maybe on kind of the communications business. And what do you see as catalyst for improvement in fiscal '25 in that business, even if they are gradual. And then just maybe as a second question, I realize probably limited updates, but any update on Spirent acquisition. Thanks.

Yes. I would just say from a spiral, I'll take the second one first. Obviously, I'm going to be limited by what I can add. But I think an update to the situation is that we've received the shareholder approval Spirent shareholder approval for the transaction, and we're working through the regulatory process. And at this point, as we have stated before, we expect the transaction to be completed in the first half of fiscal '25. As far as your original question, I mean, it is quite exciting to see tremendous demand and inflection in the wireline business. As I mentioned before, it is concentrated and it is in a supply-constrained environment. So it remains to be seen how long the manufacturing build-outs go, but that's a near-term dynamic, and we're capitalizing on it. I think the R&D opportunities associated with the multiple areas that I touched upon the key sites, engaging with customers on. We feel like it gives us a good pipeline to go execute for the next three- to five-year horizon because there is going to be bigger wave. And with any of these technology trends, hard to really see it until it happens, so -- but we're engaged and we're making meaningful contributions for our customers. But I would expect stability in wireless to continue and some increase perhaps in deployment activity across the globe, which would give further some signs of growth to our component test business there. And then as I think about the wireline side of the business, continued investments in R&D, maybe some moderating manufacturing investments in the second half of next year. So that's sort of our thinking at this point.

Great, thank you.

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

Yes, thanks for taking my question. A couple of follow-ups for me. Thanks for color on the booking trends into the October quarter. But if I were just to take a look into the Q1 fiscal year '25. Historically, Q1 has been seasonally down in terms of booking. And is there anything with the startup of new fiscal year that would make this year any different than prior years? And I have a follow-up.

Yes. I think as it relates to that by '25, I think given visibility is probably a little bit premature for us to give too much guidance. As Satish said, we are expecting a moderate recovery into '25. I think as you have just noted, in Keysight's core business, we do typically see a sequential decrease in the mid-single-digits, orders and revenue as we move from Q1 -- Q4 into Q1. The one thing that we -- you will need to account for, however, is the ESI business has kind of the opposite seasonality, recognizing about 45% -- 40% to 45% of their revenues in the first quarter of Keysight's fiscal year. So you'll have the historic history would suggest throughout the Keysight business sequentially down in ESI sequentially up, and we'll have to see how that plays out given the market environment.

And maybe Mark can make a comment on the funnel dynamics.

Yes. So Mehdi, the funnel, as we said before, is trending positive, I would say. And as I look at where we are today versus three months ago, so this is kind of a sequential trend, we're seeing more funnel intake. So that's new opportunities coming into our pipeline. And we're seeing speed or the velocity at which some of those deals are going through the funnel and closing increasing as well. So that gives us a short-term funnel that supports our guide for Q4 and we'll continue to watch this carefully, but there are improving pipeline dynamics that we're seeing in the business.

Great. Thanks for all the details. If I may just have a follow-up on that. As you look into next fiscal year, calendar year, is there anything with wireless infrastructure, anything that would help with some technology upgrade would -- and I mean like with the existing base stations would need to be upgraded from a not a stand-alone to a stand-alone? Or is there anything else that is out there that would also help with the upgrade? Or is the recovery in the core telecom wireless silicon is going to be driven by just a capacity expansion?

Yes. It's a really good question, Mehdi. I think the thing about our business is we tend to be more on the R&D labs of our customers. So we're on the front end. So towards that end, we see continued progression of standards, release '17, release '18, release '19 coming in and new teams such as AI in the context of RAN becoming real, open RAN deployments or Open RAN interoperability labs around the world are scaling. So all those are, I would say, positive trends from a sequential basis. Obviously, were down from the peak as the capex cycle from telcos are down. But the stability in the business is good. We feel good about our engagements around these next-generation themes that I mentioned, and then some earlier activity around 6G is picking up, which we're making contributions to. So -- but again, I would expect that the 5G business will have some stability because there's more deployment activities around the world, and that should provide some more stability until six GRIs.

Thank you.

Thank you.

Next question comes from Adam Thalhimer with Thomas Davis. Your line is now open.

Hey, good afternoon guys, nice quarter.

Hi, thank you, Adam.

Sorry if I missed this, but the sequential revenue growth that you're looking for in Q4, is that weighted more towards communications? Like do you expect both segments to be sequentially up?

One moment. But yes, so this is the seasonal uptick, obviously, we see in both businesses. It's probably going to skew a little bit more towards the comms business than the industrial business at this point, given some of the pressure that we continue in manufacturing and automotive that Satish just shared.

And typically, end of the year, Adam, we would expect a seasonal uptick in our Aerospace and Defense business, which has always been the case. So that's another contributor as well.

Okay. And on the semiconductor side, last quarter, you talked about fabrication delays. I think you said it might come back late Q4 or 2025. Can you just give an update there?

Yes. On the semi side, I'd say that the project activities are returning and we started to see some sequential growth. The pipeline remains solid and especially around memory, which is stronger and technologies such as silicon photonics, where we had invested with customers. And now AI is driving a higher sense of urgency to pull the trigger on those activities. Some parts on the logic side, still, it's still a mixed environment on the logic side. But we feel good about sequential recovery in that business.

Great. Thanks guys.

Thank you.

Our next question comes from Rob Jameson with Vertical Research Partners. Your line is now open.

Hi there. Yes, just a quick question on the auto exposure here. I know you talked about the EV weakness and some of the political headwinds there. But on the autonomous vehicle side, just would look to kind of have you expand a little bit on how that leads on your core communications? And maybe some color around what that opportunity might look like in the long term? And how much as a percentage of total orders that is for that business?

Yes. So thank you. As you have rightfully noted, the automotive business and the automotive marketplace is transforming, right? And I think for Keysight historically, very low exposure in that area. And as we have said before, we have grown the business to $500 million almost from a very small base. And a big part of that was really manufacturing, one-third of the business is manufacturing and production where we are engaged in the electronics manufacturing of it, and we have a differentiated position there. Two-third of the business, obviously, is all new mobility EV that Mark Walls talked about earlier and AV as well. And it's a marketplace that continues to transform. On one dimension you have Chinese battery, call it, commoditization pressures that customers are feeling. And yet the regulations around batteries and their safety needs dictate more testing there in region. And on the other side, I think the commercial ecosystem is starting to engage directly with automakers. And that's what Mark defined as the software-defined vehicle opportunity set with silicon software combining and it really plays to Keysight's traditional strength, and it's more an extension of what we do for traditional comps customers and we're able to take those and go to market for them. Mark, anything further?

Yes. No, you hit it on the last part. I was going to point out that this crosses over many parts of our business going back many years from our semiconductor and our comms EDA design tools to more and more our security and cyber types of tools that go into these environments with silicon. They obviously leverage our strengths in commercial comms, which we've been capturing for many years with communication standards, connecting vehicles to everything into the components that are used to sense as well as the computational capabilities and the standards that go within the digital standards and the optical standards that go within the vehicle itself. So that's the -- from radar to connected cars, this is crossing over multiple areas where Keysight has a leadership position, and that's why we continue to see such an active customer landscape.

That's really helpful. Perfect. And then I guess just one last one. I know there was a lot of volatility in the end of July. But just curious on demand trends through maybe the back half of the quarter and an early look into August. Was there any material changes or is it just kind of like plotting along or any positive negatives that we should be aware of?

Now, we saw ramping in the quarter from month to month, but it wasn't necessarily unusual. We ended our first half in May, and that typically pull some business in because we -- most of our sellers are on a six-month quota. So we had to start a little bit with the depleted funnel, but then we quickly grew that in. As I said, what we've seen throughout the last three months is the positive funnel dynamics, which is more funnel intake and then moving that business through the funnel. So I would say it was a fairly typical seasonality to the quarter, and we're two weeks into Q4 now.

Great, thank you.

Thank you.

Our next question comes from Samik Chatterjee with JPMorgan. Your line is now open.

Hi, this is Priyanka Thapa on for Samik Chatterjee. Just one question. You stated that you have a huge opportunity set because of hyperscaler investments. Are these hyperscalers direct customers for test equipment relative to the AI data center equipment testing? And which kind of areas can you potentially see this exposure to hyperscalers broadening out over time? Thanks.

Thank you, Priyanka. So what I stated was obviously the hyperscaler investment in digital infrastructure upgrade and the capital equipment being deployed to upgrade the networks to be more AI ready, if you will, is proliferating through the ecosystem and the large supply chain, and we're benefiting from the manufacturing exposure there. So that was point number one. But we're increasing our exposure as some of the hyperscalers enter into silicon programs and build their own organic capability, that's a growing customer base that we're continuing to expand into. We're also participating in consortiums for more open standardization that some of the hyperscalers are leading. So we're making a growing contribution there. And we feel good about our ability to take the physical and protocol layer assets into this marketplace and provide total solutions for customers, not only in traditional areas you would expect us to in computation or connectivity, but also into emulating training and inference scheme so that AI can scale effectively.

Thanks.

Thank you.

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

Well, thanks, Sierra, and thanks, everyone, for joining us today. We look forward to seeing you at the upcoming conferences this quarter and have a great day.

This concludes our conference call. You may now disconnect.