Keysight Technologies, Inc. — 2024 Q2

Yes. So yes. So first of all, I agree with your assessment of the typical seasonality of our business as we typically move from Q2 to Q3, I'd say the small downtick in both orders and revenue would be typical for seasonality, admittedly hard to find over the last couple of years, COVID, recovery supply chain. But if you went back in time, that would have been the typical seasonality. Then with the mid-single-digit uptick into Q4 driven by [indiscernible] annualized sales cycle or second half sales cycle as well as the strength of aerospace defense business tied to the government fiscal year-end. And I think that's largely what we're seeing here this year as well as we -- in terms of our expectation for the remainder of the year.

Thank you, Rob. I think this quarter for the first time in 6 quarters, our commercial communications orders grew, and as a result of the inflection that we're seeing in the wireline business associated with AI. And it's still very early days as the world continues to look at all of the applications that could be launched leveraging AI at scale. And I would say it's still very early days even for Keysight's business. So what we're seeing is probably a first inflection, I would say.

This is Will Bryant on for Mark Delaney. So in your press release, you all reiterated that you are assuming modest order growth in the second half of the fiscal year. Can you give us some additional color on what gives you confidence that the orders will pick up in the second half?

Yes. Thank you. I think what we have said is the market environment remains unchanged. And as we said in the previous call, we're not -- our base case does not assume any significant market recovery, right? So barring that is just a seasonal uptick in Q4 as Neil just referenced coming from our aerospace defense business. But we are continuing to feel that the demand environment is stabilizing. I would say, as I pointed out earlier, Wireline inflections and demand remains strong. I'd say the aerospace defense is stable. And our ISG business, which had -- which had seen 4 quarters, including the current quarter of declines stemming from normalization and manufacturing is also starting to show some seasonal -- or starting to show some sequential growth, I should say, this quarter, all of which we view as sense of stability in the business.

That's helpful. And just 1 quick follow-up on just thinking about how you guys are managing OpEx as you guys are planning the business in these volatile end markets. Could you give us any additional color about what you want to manage OpEx?

Yes. First, I'd remind you of the statements we made a quarter ago that we do expect if excluding the additional OpEx from our acquisitions, our total OpEx spending to be down about 3% on a year-over-year basis with all of that savings coming from the SG&A line items as we look to maintain our investments in R&D to ensure that the business is well positioned to capture the upswing when it occurs. .

Yes. So I'll take the first question, sizing of [semi and then] hand it over to Mark to make some comments on the market. What we've said is that our semi business is kind of 10-ish percent of total Keysight maybe a little less.

Okay. Yes. And then in terms of the fabs and the delays of timing, we've been watching that closely over the last several quarters, we have seen some movement. We've said before that our funnel gives us about 6 months of visibility out into market timing, and we're starting to see some activity that would suggest that some of those fab expansions that have been delayed the funding associated with them should be beginning to show some signs of CapEx spend towards the end of the calendar year. But we're watching it very closely.

And then last point of you question was on interconnect -- last part of your question, I didn't want to miss it. It was our interconnect technologies. And as you think about data center coming from today's node sizes of $300,000 or $250,000 to $1 million and beyond. At some point, I think interconnect has become very important. The nature of those interconnects, the high performance requirement associated with them are critical, and therefore, interoperability testing needs are key and key sites, differentiated technologies across our core product line is playing a critical role already, and we'll continue to play a critical role moving forward to help our customers.

Thank you, Meta. Again, we're quite pleased with the acquisition. The performance in the first half has exceeded our initial plans, so which is good. Again, I view this simulation and emulation as a long-term strategic priority for the company and ESI was clearly -- gave us some differentiated capability to go pursue it. The culture fit 1, 2 quarters in is re-traded because our teams are working seamlessly, the collaborative culture, the focus on technology, all of those things are headed in the right direction. .

Thanks, Satish. It's been an exciting quarter and half for us as we've begun to work more closely across different geographies, really the plan that we put in place back in late Q1 continues to be the plan we're executing around our common areas of focus from a customer standpoint in North America, where ESI is underexposed with aerospace defense. And then in both directions around auto, especially in Europe, we're seeing opportunities open for both our classic business and working closely with ESI.

And just a quick comment on long-dated orders. The mix of long-dated disorders within the quarter were consistent with the recent past.

Thank you. As far as being a company we've known for some time, we used to have a partnership with them. And I think the rationale headlines are: first, it's a SAM expansion opportunity. You think about the portfolio aspirant with focus on service assurance, positioning really a good fit to that network analytics expansion opportunity I laid out at the Investor Day. And then when I think about the financial aspect of this deal, I think it creates value for customers and more scale and synergies inside the Keysight environment, but equally for our shareholders, it's a good deal from a point of view of -- it meets our hurdles, M&A hurdles internally and it's accretive to gross and operating margins post integration.

Yes. And then getting to your question on free cash flow and working capital. So obviously, free cash flow is a little bit softer within the quarter, but pointing out north of $350 million through the first half of this year. .

Yes. Thank you, David. I think, look, we look at it 1 quarter at a time. And so far, our focus has been on execution in our discussion with customers, I would say that's the most relevant 1 as many customers have commented that they are going through the bottom. -- has their own economics improve. They've come back and they have doubled down on the programs and projects that we've been in discussions with. So that inflecting nature that correlation to their business is perhaps the most important 1 that we look at.

Yes, David, I would just simply say our pipeline supports this expectation of the modest improvement in H2 orders driven by the seasonality in Q4. Funnel intake, which is growth of new business into the funnel is up in pockets with the green shoots that we've already spoken about with AI and wireline memory, and continued demand in the longer-term secular businesses that we've spoken about with aerospace, defense and EV. We have not yet seen the lift from the U.S. defense budget being signed in the middle of March. So we hope to see some of that come through as well.

No expanded actions. I think if you're looking at the reconciliations that were provided -- the category is actually listed as restricting other and there was a modest legal settlement that occurred within the quarter as well that's skewing that number higher.

Yes. I think I would say the answer is twofold, right? One is on the order line, we think the demand environment improves a bit as we go into the second half, especially Q4, driven by some of the semiconductor spend that we're expecting to land in Q4, but again, revenue would be offset because some of the business that we book in the EISG does have a bigger percentage of long-dated sort of backlog items. So it is twofold. We expect that Neil can give us -- we would expect that revenue would be -- would face some headwinds in the second half even as orders improve. .

Yes. As you think about the margin situation in EISG, I highlighted kind of 3 factors, right, the seasonality of ESI, which is strongly profitable in Q1 in a modest loss position in the remainder of the year, that is impacting ISG profit. But by far the biggest -- the biggest driver is the revenue decline, right? So revenues down sharply here in Q2. And I think as long as we're operating in these revenue ranges, it's going to be reasonably range-bound in the current operating margin vicinity.

And just want to add on the order line. The EISG business in Asia went in about 2 quarters after CSP. So that was just lapped at the end of Q2. So that gives us some confidence that the comparison lease will be getting easier in the second half.

Well, first of all, from a timing perspective, it's very early days for the AI opportunity primarily because there are obviously logical areas where we engage with customers, but we have several active collaborations underway around silicon, 1 on real-time training of clusters, interconnects, testing methodologies for benchmarking AI, protocol aspects of the new standard [EUEC] transceiver manufacturing interoperability. So while we are in booking some business today, and we have some several active collaborations underway which are quite promising, and the ecosystem of customers that we serve will expand over time.

Yes. Thank you, Mehdi. So I know you asked several questions in one, but let's make sure I hit all of them. But I'll start by saying, look, we feel really good about our long-term growth expectations for the business. And as we laid out the 3-pronged growth strategy at Investor Day, we see these technology trends are accelerating. We see transforming industries increasing our ecosystem of customers we can serve, and we see market dynamics with governments around the world investing for organic IP. So none of those have fundamentally changed, and we feel like we're in a good position. And if you look at our strategy through this downturn is to continue to invest in R&D in a prudent way, but really focus those investments on where our customers need the most help, especially in the R&D labs of our customers making us more strategic and the cost actions that we've taken in navigating this downturn has been largely on the SG&A line. So we feel good about the opportunity that we see ahead. .

Yes. I think over time, Mehdi, but I think in the short run, the way we think about free cash flow internally is we look for a relatively high conversion of non-GAAP net income into free cash flow. And we've talked about running that in the 90% or higher range. And so while we don't have a specific free cash flow guide that we put out there, I think that's how we think about it over the longer term. The 1 thing that I would say, and you can see this by looking back in our history, is that there are periods of time where we have kind of nonstandard cash flow items that can reduce that level of free cash flow conversion. And specifically, I'm thinking about things like restructuring costs. And most notably, given where we are right now, M&A costs, either integration or transaction costs associated with M&A.

Thank you, everyone, for joining us, and we appreciate the opportunity to speak with you today. We'll turn it back to Sierra just to wrap up and close the call.