Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Second Quarter 2019 Earnings Conference Call. My name is Christine and I will be your lead operator today. After the presentation, we will conduct the question-and-answer session. [Operator Instructions] Please note that this conference is being recorded today, Wednesday, May, 29 2019 at 1:30 p.m. Pacific Time. I would now like to hand the conference over to Jason Kary, Vice President, Treasurer and Investor Relations. Please go ahead, Mr. Kary.

Thank you and welcome, everyone, to Keysight's second quarter earnings conference call for fiscal year 2019. Joining me are Ron Nersesian, Keysight President and CEO; and Neil Dougherty, Keysight Senior Vice President and CFO. Joining us in the Q&A session will be Mark Wallace, Senior Vice President of Worldwide Sales; and Satish Dhanasekaran, President of the Communications Solutions Group. You can find the press release and information to supplement today's discussion on our website at investor.keysight.com. While there, please click on the link for quarterly reports, under the Financial Information tab. There you will find an investor presentation along with Keysight's segment results. Following this conference call, we will post a copy of the prepared remarks to the website. Today's comments by Ron and Neil will refer to non-GAAP financial measures. We will also make references to core growth, which excludes the impact of currency movements and acquisitions or divestitures completed within the last 12 months. You will find the most directly comparable GAAP financial metrics and reconciliations on our website. 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. The company assumes no obligation to update them. Please review the company's recent SEC filings for a more complete picture of our risks and other factors. Lastly, I would note that management is scheduled to present at upcoming investor conferences in June hosted by Baird, BAML and Stifel. We hope to see many of you there. And now I will turn the call over to Ron.

Thank you, Jason, and thank you all for joining us. Keysight delivered an outstanding second quarter with both record revenue and record earnings exceeding the high-end of our guidance and very strong free cash flow. Our continued focus on our winning strategy and commitment to operational excellence under the Keysight leadership model are delivering strong results for the company. Today I'll focus my formal comments on four key headlines for the quarter: First, Keysight delivered another record quarter and exceptional results. Revenue was well above our guidance and grew 9% or 12% on a core basis to surpass $1 billion for the fourth consecutive quarter and to reach a new high. We also achieved record gross margin, record operating margin and record earnings. We grew earnings 47% to reach $1.22 per share, which was well above our guidance. And we generated strong free cash flow of $192 million. Second, we are complying with the recently announced United States Department of Commerce export control regulations with regard to China and Huawei. Outside of China, we continue to see broad-based momentum across multiple end markets. Customers continue to make R&D investments in next-generation technologies, which helped fuel growth in Q2 and we expect will drive Keysight's growth to between 7% and 8% for the fiscal year 2019. Third, we are significantly ahead of our plan on the margin expansion and earnings objectives that we outlined last year at our Investor Day in March of 2018. We now expect that we will achieve the gross margin and EPS targets outlined for fiscal year 2021 in this year fiscal 2019. This is two years ahead of plan. We remain focused on operational excellence as defined by our Keysight Leadership Model or KLM. This discipline is driving margin expansion and translating into strong earnings growth…

Thank you, Ron, and hello, everyone. Before I get started, I will note that all comparisons are on a year-over-year basis unless specifically noted otherwise. As Ron mentioned, we delivered another strong quarter as we continue to execute on the demand we see in core areas of our business, while maintaining focus on operational excellence. For the second quarter of 2019, we delivered non-GAAP revenue of $1.093 billion, which was well above the high-end of our guidance range and grew 12% on a core basis. This brings our revenue growth for the first half of the year to 13% or 15% core growth. Our better-than-expected Q2 results were driven by continued strong demand especially in 5G where we have a leading position as well as superior execution by the entire Keysight team. I will also highlight that in Q2 orders for services grew double digits. Services demand was broad based and we saw good adoption of our new support offering, such as Keysight Care. Total Keysight orders exceeded revenue once again this quarter. We delivered $1.121 billion in orders in Q2. Orders were up 14% in total and 16% on a core basis. Looking at our operational results for Q2. We reported record gross margin of 64%. This represents our second consecutive quarter of delivering record gross margin. As Ron mentioned, our growing contribution of software revenue is helping increase our overall gross margin profile to a new level. We also delivered record operating margin and earnings. We achieved 25% operating margin and net income of $233 million. On a per share basis, we delivered $1.22 in earnings, which was well above the high-end of our guidance. Our weighted average share count for the quarter was 191 million shares. Our Communications Solutions Group generated total revenue of $676 million, up…

Thank you, Neil. Christine will you please give the instructions for the Q&A?

[Operator Instructions] And your first question comes from the line of Vijay Bhagavath from Deutsche Bank. Your line is open.

Yes, thanks. Hey Ron, Neil.

Hi Vijay.

So please double-click on your China exposure Ron and Neil please chime in. I would like to better understand the dynamics playing inside of China and then ex-China I want to get your sense on your 5G business in particular any slowdown you anticipate outside of China potentially because of the Huawei kind of the whiplash effect? Thanks

Thank you, Vijay. I'll make a general comment then I'll pass it over to Neil to talk about the China implications and then I'll let Satish say a couple of things about our overall very strong 5G business. So with regards to China and Huawei in particular we are complying with all U.S. regulations and monitoring and assessing the situation as it evolves. There are certain circumstances during this next 90 days or this 90-day period where we can ship some products to Huawei, but we obviously have other backlog and other business that we typically do get for them that we will not be able to ship. Outside of this regulation our business is firing on all cylinders and we continue to grow and that's why we have guided $1.01 for Q4 in the middle of our range -- for Q3 which is in the middle of our range, despite taking into account all of these effects.

Yes. Vijay if you look specifically at the Huawei impact for Q3 we've reduced our revenue guide for next quarter by about $25 million as a result of the escalating trade situation in China. The impact in the fourth quarter is larger just based on the funnel of opportunities that we had which was more heavily weighted towards Q4 versus Q3 and in the second half of this year. I think to just to echo Ron's point, we'll have to have a bit of a reset for this customer situation that we're going to lose, but the underlying business continues to grow very, very strongly. We're very well positioned in a number of end markets that have -- that are just at the front end of the ramp in terms of automotive and 5G with a strong funnel of opportunities in aerospace defense that we talked about and so we continue to be very optimistic about how Keysight is positioned as we look forward.

Hi, Vijay. At the onset I want to start by saying on a global basis despite the recent events we continue to see momentum on the 5G trajectory both for our solutions and the entire ecosystem that's scaling. In the most recent quarter all our regions -- all the four regions showed strong year-over-year growth. We've added 100 new customers in the first half into our 5G platform relative to the previous half. And we continue to see some notable highlights in the most recent quarter which illustrates my point. First, we saw component supply chain enter into 5G and based on the strength of our modular platform. Second the NEMs who have been declaring public contracts have actually been investing in ramping up capacity for base stations which is a positive. And third as 5G scales and deployment scenarios are being played out, the complexity as we've talked about has been high and we've recorded design wins for our deployment tools. Again very early stages, but hopefully paints the runway that we have moving forward.

I'll just add one other comment. As Satish had mentioned all of our regions grew triple-digits in 5G and overall, we were very strongly into triple-digits.

Yes, perfect. It's great to hear this level of transparency into your business. Thank you.

You're welcome.

Your next question comes from the line of Brandon Couillard from Jefferies. Your line is open.

Thanks. Good afternoon.

Hi Brandon.

A question for Satish on the same topic. As you kind of look out to March of next year and sort of the finalization of the timeline for 5G standards, what impact do you think the Huawei situation might have? And if that is delayed to all how much of an impact do you think that has on sort of your business and sort of the ecosystem?

Yes. There's a lot of possible scenarios that can play out, but I would say if you look at the top drivers that we look at is the number of operators that are actually committing and are deploying 5G. Currently that stands at 20 and it's increasing. If you look at the number of network equipment contracts that people have declared publicly that's been increasing throughout the year. If you look at the number 5G devices that are being put out, it's about 30. So, those are things that we look at to say is the industry dynamic strong and it continues to be strong and healthy. If you look at the standards, I think you point out that the 5G standards are maturing and that's good for Release 15 of the spec. We're actually leading in the - from a global conformance validation perspective in enabling the industry to roll out the technology with interoperability as its core theme. So -- and with standards starting to work on Release 16, the innovation drivers, especially in R&D, continue to be strong and robust. And we see some reports that suggest that as share shifts occur, different players will continue to ramp investments and I think given the strength of our position over the last three years in 5G, we're well-positioned to capitalize under various scenarios.

I'll just add two more comments with regards to 5G. First I will say that even if you were to take Huawei out of our orders, 5G still grew 198% in the quarter. The second point that I'll add is 5G relative to legacy cellular technologies, our 5G orders have surpassed all of our legacy cellular technologies for the second quarter in a row. So, we have a very high growth component from 5G that is now larger on a dollar basis which will carry a higher weighted average impact to our overall average growth rate.

Thank you. That's very helpful. I appreciate the color. Maybe a question for Neil just on the incrementals in the second quarter, pretty remarkable especially in CSG, I think incrementals over 100%. Can you sort of speak to where all that margin is coming from and perhaps the impact of yields greater software mix on the gross margin line? Thank you.

Yes, Brandon thanks for the question. I think there's a number of things. Obviously, at Keysight, we are consistently focused on operational excellence and driving improved profitability across the entire platform. I think in Q2 we did see a very favorable mix in our revenue during the quarter, both from software which grew faster than the overall rate of growth of the total business as well as some very favorable mix in some of our solutions platforms that were added into gross margins. So, we put up two consecutive quarters now of record gross margins with Q2 being close to 200 basis point improvement and over the prior record. I think as we look forward we're very encouraged by the gross margin profile that we see. It's not quite as strong as what we saw here in the second quarter, but we're very encouraged by the gross margin profile that we have which is driven by the solutions approach that we're taking to the market.

Super. Thank you.

Your next question comes from the line of Jim Suva from Citi Investments. Your line is open.

Thank you. You've been very clear and transparent which is appreciated on the Huawei challenges given the trade war tensions and tariffs and such. However, what I'd like to do is increase the scope a little bit. If my memory is correct, I believe, China is closer to like an 18% of your total sales. Do these new tariffs impact that or the customer behavior or any other potential customers indirectly? Because I know that the supply chain is very complex, but again, you spoke about Huawei and I think all the questions are answered there. But anything about broader China and these tariffs we should be aware of that you're working on or keep an eye-on on your dashboard? Thank you.

Yes, hi, this is Ron. China is about 17% to 18% of our total business. We have looked at the indirect China impact on what is going on talking with our sales organization on a daily basis all of that has been included in the guide. Things can change in the future, but we're doing things such as redeploying our sales force from an account that can't sell on into other areas. On top of that Mark Wallace is also expanding the sales force and I'll let him give you a little bit of an update on that which will drive our growth.

Sure. Thanks Ron. Hi Jim. So, yes, that's very true. In all of our regions, we're expanding our sales force on course to doubling the number of front-line sellers, so we're well on course to doing that. You heard me talk about that at the Investor Day last year. In China, the same thing is happening. We're continuing to deploy resources and we are a very resilient, especially in China to be able to redeploy resources dynamically as opportunities change. So we're doing that as we speak. I do want to point out though in Q2 with the prior headwinds that we had for semiconductors and some of the RPL companies, we still had record revenue in Q2. So there is still a lot of great business in growth. The broader business in China is holding up reasonably well. As we mentioned, we have a broad portfolio of solutions and a lot of diverse end markets including 5G, including automotive and general electronics. So the combination of our ability to cover these customers, redeploy dynamically and bring the total solution set that we've been doing to market is a formula for success.

Thank you so much for the clarification. It’s greatly appreciated.

Your next question comes from the line of Toshiya Hari from Goldman Sachs. Your line is open.

Hi, guys. Thank you for taking the question. And congrats on a very strong quarter. I was hoping you guys could talk a little bit about the competitive landscape in 5G specifically. Very much appreciate you guys have a great lead over your competition, but at the margin it does feel like your two competitors in particular are trying to play catch-up here. If you can point to some of the differentiating factors that separate you guys from the rest of the pack that would be helpful? Then I have a follow-up.

Yes. Hi. This is Ron. And I will turn it over to Satish in one minute. Obviously, if you look at the growth rates of the other – of the competitors you can see how they're doing. We don't comment specifically on our competitors, but we will tell you a little bit about our strengths. And I'll let Satish fill in some of the holes.

Yeah. Thanks, Ron. I'd say that, the first reason why customers buy from us is the experience that we've gained over the last three years working on 5G. This has been an imperative since the company was formed that Ron has laid out and we're continued to execute, but execute not just on our internal programs, but with our customers. The second reason, we feel good about our runway is because of the – our expansion into the software layers of test, which has gone on well. We've had 31 collaborations just this year that, we've announced with industry partners, which continues to build on some of the collaborations we've had, but also new customers who are entering our platform. And then third, it's all about the end-to-end equation. You hear about these as terms and jargons, but for us it means we cover the whole ecosystem with life cycle solutions. The only reason, we can do that is we have capabilities all the way from Anite to Ixia now that are providing us considerable insights and abilities to be able to execute to key milestones of our customers. So that's in short, our value proposition here.

Great. Thank you for that. And then as a follow-up, I had a question on margins and I guess this will be for Neil. Really encouraging to hear that you guys are pulling in your margin targets by two years, if you look back, what are some of the things that drove the upside to margins? Was it primarily better revenue and perhaps stronger service mix and maybe high-value add products from 5G? Is there anything that I'm missing there? And then more importantly, going forward, how are you guys thinking about gross margin as well as operating margin? Is it more about revenue growth going forward or is there opportunity to expand margins further? Thank you.

Yeah. I think you hit most of the items. Obviously, we continue to see our software business outpace the overall growth of Keysight in total. And over the past couple of years that growth has been significantly above our long-term model. And as we've talked about, we have a great ability to drive leverage – profit leverage from growth. I think, if I were to step back big picture and say what's driving our improved gross margins, it's the fact that, we have changed our approach to go-to-market to one that's focused on end industries, and industry segments and bringing complete high-value solutions into the marketplace. And those differentiated solutions are enabling us to increase the gross margins. The other thing that we've talked about repeatedly is our kind of decade long at this point or more than decade-long effort to migrate more of our solution selling into our customers R&D labs, and really target the areas of manufacturing that are higher margin opportunities. And so all of those things in concert are now starting to hit and they layer on top of one another and are starting to have a very measurable impact for the company.

I'll just add a little bit more. We have really focused on operational excellence and we have a program that's in place across all 12,900 employees here at Keysight to improve operational excellence, which is part of our Keysight leadership model. But Neil has really hit the nail on the head. It's our differentiation, when our customers go ahead and they look at total solutions, which is not only the world's best hardware, but the best application and measurement IP and software as well as our services capability across a broad range of products, we bring solutions that cannot be brought to bear by many of our competitors. And this is giving us the ability to not only do a great job of selling our products, but to also capture this differentiated value.

And then on the go-forward basis?

Just what I said over the kind of intermediate term as we look into the second half of this year, the -- our gross margin strength and our funnel and then our backlog is strong, but it's not quite at the level of what we're seeing here in the second quarter. But we continue to see very strong gross margin as we talked about. We believe we've achieved and can sustain the FY '21 gross margin target that we outlined at Investor Day in March of last year.

Got it. Thank you.

Your next question comes from the line of Richard Eastman from Baird. Your line is open.

Yes, good afternoon. Ron, can I just circle back for a minute or two around 5G in China and in particular Huawei, was there a significant kind of patent to the IP around 5G and the different dynamics there? Is there a sense that could Huawei look to other vendor’s non-U.S. vendors on the test side if this stays -- if this kind of restricted list kind of stays in place? And how does that restricted list, I mean this is different from the tariff resolution but how does that issue get resolved from your perspective? I mean maybe those are the two questions around Huawei and 5G?

Yes. The first thing that I'll say is with regards to Huawei, if they cannot sell for instance into the U.S. and into some other countries that business will go somewhere else. And again they'll capture some of the business, but other business will go to players such as Samsung or Nokia or Ericsson and we're not here to predict which one will win, but all I can tell you is we've very strong positions in all of them. So some of that business can be displaced into some of their competitors. We do have a competitor in Japan and a competitor in Germany, Anritsu and Rohde & Schwarz but we have been significantly ahead of them and we believe we still will be very well positioned as we go forward in the future.

Okay. And then just maybe a follow-up question on Ixia maybe for Neil. Can you just -- great progress all over on margins here in the other segments, but could you just kind of maybe lay out some sort of a roadmap for Ixia's profitability? I mean is that due mainly to investment or is our single-digit operating profit at Ixia, does it move to double digit over the course of 18 months or 12 months or how do you see that unfolding here?

Yes. We definitely see an intermediate to longer-term opportunity. We have a pretty dramatic improvement in Ixia's profitability. I think we're continuing to wait for the 400-gig ramp to hit the Ixia portion of the business. We're seeing that pretty strongly right now in Satish's business on the physical air side, but we know that the protocol layer sides are going to lag. And so we'll look to the back half of this calendar year or early next calendar year for those to hit. Ultimately with the business that has 70-plus percent gross margins the best way to fix the bottom line is to get the business growing again. I do think it's worth noting from a profitability standpoint just reiterating the points that I made on -- in the prepared remarks we have generated $50 million of cost synergies in this business or as a result of this transaction, but 70% of those synergy value is actually being realized within our Communication Solutions business and Electronics Industrial Solutions business. And you can see that in their increased levels of profitability. And so you couple that with the variable pay impact of having -- that comes with our variable pay programs that are based on organic growth and operating margin we're paying out at historically high levels. And the Ixia picture is far better than maybe it would appear if you just look at our segment results.

I would also add on top of that, we are investing in R&D at a higher percentage of revenue than has been done in long period of time, if not ever. And you couple that with the life cycle investment that we expect to see in some of their solutions and we feel like we have some real movement that will happen there.

Okay, very good. Thank you.

Thank you, Rick

Your next question comes from the line of John Marchetti from Stifel. Your line is open.

Thanks very much. I was wondering if maybe we can shift gears just a little bit and talk about the ADG group and that slowdown there this past quarter, it sounds like the U.S. remained relatively stable for you, but you did see drop off sales as well. Just curious how to think about some of the puts and takes there going forward as we look to the second half of this calendar year?

Yes. Thanks John. I will just say this we have a very, very full funnel right now. Obviously all of it has not been released but I'm going to let Mark Wallace tell you a little bit more about the details.

Yes. Okay. John thanks for the question. Q2 of 2019 was first of all tough compare. It's the second largest Q2 for orders since we formed as Keysight. So we had a decent quarter and as you pointed out the growth that we realized from the U.S. was coming both from the direct government and some of the contractors. The other thing that is not as visible all the time is that our services business as part of solving customer's problems within aerospace defense continues to grow and that's true around the world, and in particular we're hoping to optimize their equipment uptime and utilization. And I see a lot of runway here to complement our high-end equipment and solutions business. The other thing is there is pent-up demand in the U.S. in particular, because there are some continuing delays in funding and appropriation. While we saw some of that release in Q2, we'll be monitoring this very closely, obviously as we get closer to the end of the fiscal year for the U.S. government. And you know what 5G is everywhere. We're seeing 5G opportunities in aerospace defense as well we're seeing 5G opportunities in automotive. So our broader solution set as well as our footprint is applicable here in aerospace as well. So the longer-term outlook remains unchanged. We will see continued investment because of increased R&D spending for some of the advanced technologies that we have great solutions for.

Thank you. And then maybe, Satish just a quick question for you on the broader outlook for 5G, I'm wondering, if you can comment at all on sort of sub-6 versus millimeter wave. Where you're seeing some of that activity? And if anything that's happened recently certainly impacts that or how you look at those two sort of competing versions of 5G developing going forward?

Yeah. I think a good question. To start-off, I'd say clearly, the ecosystem is ramping and it's ramping sort of based on regional needs some parts of the world, starting to deploy sub-6 gig first, and some have started with millimeter wave and the densification play with 5G. The strength of our platform is that, we've designed it to be modular from grounds up. You start-off with sub-6 gigahertz add millimeter wave or you start-off with an SA, which is the stand-alone version and get to NSA and vice versa. Because of this sort of ability to move seamlessly between different implementations, we're able to service the global ecosystem which is why our 5G orders for this quarter ended on a record note and we continue to see that moment build out.

Thank you.

Thank you. That concludes our question-and-answer session for today. I would now like to turn the conference back to Jason Kary for any closing comments.

Thanks, Christine, and we appreciate everyone joining us on the call today. To close this out, I'll turn it back to Ron for some final comments.

Thank you, everyone, for joining us. We really appreciate you staying with us and we really appreciated the chance to share these Q2 results with you. Obviously record Q2 orders for the highest Q2 in history, record revenue, record gross margin, record operating margin and record non-GAAP EPS makes us very happy. The other thing that was very impressive was our strong EPS growth at 47% in Q2 and 60% in the half and our $192 million of free cash flow, which was an 82% conversion. Also we're very glad that we were able to deliver to you a revenue and EPS significantly above the range. But what makes us even more excited is as we look forward, the margin expansion programs that we've been working on for years have paid off and they paid off early and we believe that will generate lots of cash for us as we look to the future and accordingly we have put in place a $500 million share buyback program, thanks to our Board of Directors. But we're very bullish on the future and on our growth initiatives going forward. Of course, you'll have a bump in the road here and there with some competitors but we are growing on so many different vectors, we look forward to reporting to you next quarter. Thank you very much and have a great day.

This concludes our conference call. You may now disconnect.