Keysight Technologies : Second Quarter 2024 Prepared Remarks

Keysight Technologies Second Quarter 2024 Earnings Conference Call

Prepared Remarks

JASON KARY

Thank you, and welcome everyone to Keysight's Second 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 will 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 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 twelve 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 Baird and UBS.

And now I will turn the call over to Satish.

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SATISH DHANASEKARAN

Good afternoon, everyone, and thank you for joining us today.

My comments will focus on three key headlines.

• First, Keysight executed well in a market environment that was largely unchanged from the first quarter. Revenue of $1.2 billion and earnings per share of 1 dollar 41 cents exceeded the high end of our guidance.
• Second, orders of $1.2 billion were in line with the prior quarter. We saw pockets of growth and stability across multiple end markets even as customer spending remained constrained. Our base case scenario for the full year is unchanged, with revenue relatively stable from Q2 to Q3, and orders increasing modestly in the second half.
• Third, our deep customer collaborations and relationships are strong and continue to inform our future roadmaps. These engagements reinforce our confidence in the long-term secular growth trends of our markets. The pace of innovation is accelerating across multiple vectors. And, while remaining disciplined, we are investing to increase our differentiation and to capitalize on the waves of technology inflections ahead of us.

Now let's begin with a brief overview of Keysight's second quarter performance. Revenue of $1.2 billion and earnings per share of 1 dollar 41 cents were above our expectations. Revenue and orders continued to normalize from the strong prior year, but were stable on a sequential basis excluding ESI seasonality. We delivered operating margin of 24%, reflecting a healthy gross margin of 65% and the cost actions and discipline that we have exercised to-date.

Turning to our business segments…

Communications Solutions Group revenue declined versus the prior year, which benefited from robust backlog conversion. On the demand front, orders were flat year-over-year and grew four percent on a sequential basis. Investment in defense modernization continued to drive activity in aerospace, defense and government. And we were pleased to see commercial communications order growth for the first time after 6 consecutive quarters of declines.

Wireline orders grew on robust demand for our differentiated AI data center solutions. These include a new AI Test Platform that is being used by several industry leaders to emulate AI workloads and benchmark network performance. Hyperscaler customer engagement remained high as they accelerated their AI application development. We deepened our R&D collaboration with Nvidia on next-generation communication technologies this quarter. We also saw strong demand for AI infrastructure solutions, including test and validation of 400 and 800 "gig" transceivers, and ultra-high- speed interconnects in GPU-based compute systems. Our advancement of leading-edge network innovation was on display at the Optical Fiber Conference, where we demonstrated the industry's first

1.6 terabit Ethernet test solution in partnership with industry leaders.

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In wireless, there are some encouraging signs of incremental improvement in the industry outlook as parts of the ecosystem continue to normalize. Our latest suite of 5G solutions launched over the past year is enabling ongoing investment in the evolution of 5G standards, non-terrestrial networks, and Open RAN. With the first round of NTIA grants to enhance testing of interoperability, performance, and security of Open RAN networks, we secured key wins with several customers in the U.S. We also saw increased demand for chipset R&D, as well as component production. Earlier in the quarter, we partnered with industry leaders to showcase new products and solutions at Mobile World Congress, including non-terrestrial network chipset development with Qualcomm.

Turning to aerospace, defense and government, defense modernization spending continued in radar and spectrum operations, space and satellite, and signal monitoring. We saw healthy demand from the U.S. Government and Primes in the quarter. After several "continuing resolutions", the 2024 U.S. defense budget was approved in late March. It includes a 5 percent increase for Research, Development, Test & Evaluation, which is expected to drive incremental program spend. Strong demand for electromagnetic spectrum operation applications resulted in significant wins at U.S. and European Primes. We expect this trend to continue into the second half and 2025.

Turning to the Electronic Industrial Solutions Group, orders and revenue continued to normalize from a record prior year, declining double digits as expected. Customer spending and market conditions remain muted, but we saw relative stability on a sequential basis.

In semiconductor, the industry outlook is improving with projections of recovery in 2025. Inventories are coming down to more healthy levels, and demand is picking up in certain areas, such as high- bandwidth memory. Additional new fab installations were also announced this quarter. In the near- term, foundry customers are working through delays in existing projects and expect production to begin in late 2024 and 2025. Consistent with this backdrop, we saw improvement in our memory- related business, and ongoing, steady demand for Keysight's proprietary laser interferometry positioning systems.

In automotive, revenue was sequentially stable when excluding acquisitions. We had steady demand for both our EV and AV solutions. Beyond the headlines, consumer adoption of EVs continues to grow, although at a slower pace. The development of cost-effective,longer-range batteries and a more robust charging infrastructure remains a strategic priority for OEMs and governments in a very competitive market. During the quarter, we expanded our global battery test footprint with a new, large Gigafactory customer in Europe.

We are also pleased with the addition of ESI to our automotive and simulation software solutions portfolio. The business is tracking well to both topline and profit expectations. This quarter ESI expanded its multi-decade collaboration with the Volkswagen Group, establishing a joint material testing and intelligent simulation lab in Asia. This collaboration will advance automotive simulation technology and drive new industry standards, safety, and efficiency forward in the region.

In general electronics markets, customer spending remains constrained, particularly in manufacturing, China, and the distribution channel. We do continue to see growth in digital health and advanced research, supported by government funding in Asia and the U.S., such as the CHIPS Act. This quarter

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we expanded our partnership with EMVision in Australia to enable innovation in novel point-of-care medical imaging technology and analysis.

As a key element of our solutions strategy, software and services orders and revenue growth continued to outpace overall Keysight. At approximately 39% of total revenue, software and services enhance the differentiation of our solutions, and are more resilient in current market conditions.

Within the chip domain, next-generation performance demands are driving an exponential increase in system-level design requirements and complexity. Keysight's simulation and emulation software capabilities enable our customers to address these challenges and accelerate time-to-market for their advanced systems and chips. We recently introduced "Quantum Pro", an integrated EDA solution for Qubit design and the development of quantum computers. In addition, we launched a new solution for die-to-die interconnect simulation, which is a key step in verifying the performance of heterogeneous and 3D-integrated circuit designs, commonly known as chiplets.

Looking ahead, the pace of technology innovation and digitization is accelerating and proliferating across multiple industries and use cases. Keysight is investing today - both organically and inorganically - to capitalize on these future technology waves and inflections. In addition to steady organic investment in R&D, we are expanding our solutions portfolio and our served addressable market through M&A. This quarter, we announced our intent to acquire Spirent Communications, a highly complementary business in Network Analytics. We also completed the acquisition of Riscure in the quarter, expanding our automated security assessment capabilities and solutions for semiconductors, embedded systems, and connected devices.

In closing, I would like to thank our employees once again for consistently delivering value to our customers and shareholders. The Keysight team's high-performance and winning culture is key to our success, and a competitive differentiator.

While it's difficult to call the timing of the recovery, we are encouraged by the pockets of growth that are emerging, the relative stability of investment levels, and the strength of our customer collaborations. Consistent with the Keysight Leadership Model, we remain disciplined and continue to streamline operations to ensure strong financial performance in these dynamic market conditions. As we look beyond the current period of normalization, the long-term secular growth trends driving our business are intact. Taken together, our broad portfolio of differentiated solutions, strong customer relationships, technology leadership, and durable financial model position us well into a market recovery.

With that, I will turn it over to Neil to discuss our financial performance and outlook.

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NEIL DOUGHERTY

Thank you, Satish, and hello, everyone. Second quarter revenue of $1 billion 216 million was just above the high end of our guidance range and down 13 percent, or 14 percent on a core basis. Orders of $1 billion 219 million declined 8 percent, or 9 percent on a core basis.

As a reminder, Keysight's historical first-to-second quarter seasonality was muted by the cadence of the ESI business, with approximately half of ESI orders and revenue recognized in the first quarter of the fiscal year. Excluding ESI, orders grew 4 percent sequentially and revenue was in line with Q1. We ended the quarter with $2.3 billion in backlog.

Looking at our operational results for Q2, we reported gross margin of 65 percent. Operating expenses of $496 million were down 2 percent year-over-year, even with the addition of ESI and Riscure. Excluding these acquisitions, SG&A expenses were down 10 percent, or $29 million, reflecting the flexibility of our cost structure and actions taken to-date. Q2 operating margin was 24 percent, or 25 percent on a core basis. Despite a 14 percent decline in core revenue in the first half, first half operating margin declined 400 basis points, outperforming Keysight's downside model expectations and demonstrating the financial resiliency of the business.

Turning to earnings, we achieved $247 million of net income and delivered earnings of 1 dollar 41 cents per share. Our weighted average share count for the quarter was 175 million shares.

Moving to the performance of our segments, our Communications Solutions Group generated revenue of $840 million, down 10 percent, or 11 percent on a core basis. Commercial communications revenue of $563 million declined 10 percent, while aerospace, defense, and government revenue of $277 million was down 11 percent. Altogether, CSG delivered gross margin of 68 percent, and operating margin of 27 percent.

The Electronic Industrial Solutions Group generated revenue of $376 million, down 17 percent, or 21 percent on a core basis. EISG reported gross margin of 58 percent, and operating margin of 19 percent due to the seasonality of ESI profitability, lower revenue volume, and some unfavourability in mix.

Moving to the balance sheet and cash flow, we ended the quarter with $1.7 billion in cash and cash equivalents, generating cash flow from operations of $110 million, and free cash flow of $74 million, which reflected higher cash taxes and the timing of collections in the quarter.

Share repurchases this quarter totaled 302 thousand shares, at an average price per share of approximately $153, for a total consideration of $46 million.

Now, turning to our outlook…

We expect third quarter revenue to be in the range of $1 billion 180 million to $1 billion 200 million, and Q3 earnings per share to be in the range of $1.30 to $1.36, based on a weighted diluted share count of approximately 175 million shares.

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As we look to the full year, our base case scenario remains the same, and assumes a mid-single digit increase in revenue from Q3 to Q4, which implies full-year revenue of approximately $4.9 billion.

In closing, we remain disciplined and focused on what we control, while investing to capitalize on the best growth opportunities as markets normalize and recover. Keysight's customer focus, technology leadership, and broad solutions portfolio give us confidence in the long-term trajectory of the business and the ability to outperform in a variety of market conditions.

With that, I will turn it back to Jason for the Q&A.

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