Keysight Technologies, Inc. (KEYS) Earnings Call Transcript & Summary

We'll go ahead and get started. I'm Rob Mason, the senior analyst at Baird covering advanced industrial equipment. And welcome to the Keysight Technologies presentation. Keysight is a cornerstone piece of our test and measurement coverage. It's the largest global electronic test and measurement solutions provider, and we're very glad to have with us today Neil Dougherty, who's the Executive Vice President and CFO; and Kailash Narayanan, who is the President of the Communications segment business at Keysight, which is their largest business.

So I think we'll just go ahead and get started with Q&A here, if you'd like. So I think maybe I'll just start, Neil, the discussion around state of demand is obviously very topical. Just start at the 30,000-foot level, you had orders that had tracked about $1.1 billion per quarter prior to the pandemic. As we went through the pandemic, those ramped up to about $1.5 billion per quarter. Now that included a lot of maybe early queuing just to get customers to get in the queue. We had supply chain constraints. We're now trending about $1.3 billion per quarter, and that seems to be maybe a stable level that you're thinking about right now that you commented on both the first quarter and the second quarter and perhaps the way we're thinking about...

The back half. Absolutely.

Yes, the second half of the year. Does that $1.3 billion capture most of the true demand signals at this point? Do you feel like...

Yes. I mean I think -- so first of all, just reiterating the point, right? We do feel like based on the observable inputs at this point in time that things have stabilized at this level for us. I think over the course of the last 12 to 18 months with the supply chain disruptions, we clearly saw some [Audio Gap]. And what we've talked about is some abnormal backlog probably in the tune of $400 million to $500 million over that previous again, 12- to 18-month period of time. I think there's been -- some of this is probably a response to that, people having things that are scheduled in backlog and, therefore, not needing to place orders. But I think the macro environment, some of the broader industry-related inventory indigestion that's happening, I think right now, we're seeing, again, things kind of stabilize at this level. And I think it will be a good base for us to pick up and grow from once the macro piece of this starts to recover.

Could you [Audio Gap] so $1.3 billion in orders last quarter as well, the same as the first quarter. You peel that back just a little bit and see -- and let us know perhaps what you're seeing under the surface? Automotive was very strong, you commented on, but communications, a little more volatility, semiconductor. Can you just kind of walk through some of the segments from an in-demand standpoint right now, not a shipment somewhat?

Yes. Why don't I start, and I'll let Kailash give some deeper comments. I think as you highlighted, we saw pretty good strength in our automotive business, in our aerospace defense business were areas of relative strength. I think our general electronics business was very stable. And I think maybe that surprised a little bit to the upside given the nature of that business. And then on the downside, I think we saw relative weakness in semi, which a lot of people are seeing and then in commercial comms, where a lot of our largest customers in that space have been very forthcoming and public with some of their issues around, again, inventory issues, workforce restructuring themselves that I think are [Audio Gap] customed investment in certain areas in the comp space.

Yes. The only thing I'd add there is we do see engagements with our customers continuing to pick up and particularly in the second quarter, we saw more engagements. So there, our strategic long-term programs are intact. And we've seen more of the reduction in the manufacturing space. We have some exposure to that in the commercial comps business with the R&D programs, the long-range strategic R&D programs, both on the wireless and the wireline side, are staying more or less impacted and customers are now thinking about the 2024 programs. Yes.

Maybe we just stick there a moment, Kailash. Keysight overall, has had much more of an emphasis on penetrating R&D test to a greater degree than production test. How do you think about just on the production test side, that part of the business stabilizing? There's a lot of reorientation of manufacturing footprints. I would think that, that probably has some positive impact on your business. Does -- is that activity still ongoing? Is that accelerating, stabilizing? Maybe does that present a risk if we get out of '24 and some of that activities were to pause?

Yes. We have seen some relocation of the supply chain, partly because of post-pandemic effects, but then also due to geopolitical considerations, we are seeing a little bit of supply chain relocation and new facilities coming up outside of China. I think longer term, we do view that as a positive trend. This year, however, because of the inventory exposure that people have, it's more of a longer-term trend than something that will kick up manufacturing spend in the short term. Yes.

How do you think about -- Neil or Kailash, how do you -- I often get asked around the cycle people think in terms of the cycle. But in the test and measurement space, it's perhaps a little bit different. There's been maybe a few periods in history, you go back to the optical phase or the global financial crisis where there was some abrupt slowdown in the business. But I often get asked how deep -- how long is a down cycle in test and measurement? And when you think -- I'm just curious to get your perspective around that when you think about the diversity of applications that feed into test and measurement at the moment? How do you think about the cycle?

I think it's a hard question to answer because of the diversity of our business and the markets we serve. There's really no one singular driver or secular trend that is going to impact the entirety of our business. So if you think about commercial comms, it's been 5G for a long time, but we're already seeing the influx in to early investment. 6G is starting to kick in. You've got things like O-RAN non-terrestrial networks, which are driving ways of investment on the wireless side. On the wireless side, it's just progressing from 400 gigabit ethernet to 800 gigabit, even 1.6 terabit R&D work is happening. On our electronic industrial side, you see that in automotive, the push towards electronic vehicles and autonomous driving, semi, the move to smaller process architectures as well as the move to ensure supply by reonshoring semiconductor production are big secular themes. And then general electronics, I think you're just looking at the broader themes of digitization across a wide range of industries, right? And so there really is no one single driver. So I think for Keysight, you need to look at it on a business-by-business basis. And bring it back to what we're seeing now, again, relative softness in commercial comps in semi, but the other business is holding up really well.

[indiscernible] Maybe we'll just go to the Communications segment. Kailash, obviously, 5G has been a theme that Keysight has capitalized on, but you also have a very significant wireline-related business that plays into data center. There's certainly, everybody is aware of the buzz around AI, ML. That's not necessarily new. But in terms of maybe the demands it's going to place on networks going forward, I'm just curious how you see that Keysight's opportunity to participate there and how you're planning to serve that market?

Yes. It's a great question. And as you -- first of all, we're excited about this new use case, and we're excited about the opportunity. And as you pointed out, it's not something entirely new. And if you look at all of the wireline innovations that have been happening, whether it's say 400G network or an 800G network, they've all been focused on what's happening inside the data center and to address an AIML type of use case. So this particular use case now is reaching an inflection point. It may have been just focused on a few players over the last couple of years. And now it's reaching an inflection point the large hyperscalers are definitely taking off and their ecosystem is going to take off as this use case proliferates. Right now, the customers involved in AIML, they're largely focused on ensuring the performance of their training algorithms, the AIML training algorithms, the AIML [indiscernible] they have. They want to train the algorithms effectively. They want to have their inference engines all done in a cost-effective manner. And they have to do that by building these networks, these AIML networks. And that's pretty expensive, and it takes a lot of time. It takes a lot of money. And we have an opportunity to really provide emulation capabilities, how does the network behave, the different configurations, how does modeling and training time and cost, energy efficiency, things like that, how can you model those KPIs before you configure and deploy a network. So this is an opportunity for us. We're seeing some early success with large hyperscaler companies, and then we expect this to move forward. We also have exposure to the AIML use case through our traditional business. When you look at things like GPUs, CPUs, we have exposure to that. There's going to be more GPUs. There's going to be more CPUs. Our semi business is going to be benefited from that. There's going to be more activity from a chip R&D perspective. So there's going to be more AIML focused chips. That means more R&D spend in a chipset development and functional chipset test, things like that bode well for us. We also see a more conversion of technology from electrical to optical. So optical is a little bit more efficient. It's faster. So at the chiplet level, you have integration of optical technologies, things like silicon photonics. So we have exposure from that perspective. And then within data centers, you've got east-west traffic, data traffic moving between the servers and everything from switches to routers and these high-speed digital interfaces to take advantage of this opportunity. So we do see this as part of our SAM, but this part of SAM is starting to inflect.

I think last quarter, you mentioned a little bit of softness on the 400 gig side, maybe just thinking about how that pause plays out. Do we see that recover? Or is it led out by 800 gigabit? Or did we move on to terabit, how that plays out?

Yes. 400G initial deployment occurred -- started to occur, maybe 18 months [indiscernible] we do see 400G manufacturing picking up once this macro subside, we do see 400G manufacturing pick up next year, while 800G R&D has already started to pick up, right? It depends on different hyperscalers, different companies, they have different network architectures. Some could deploy AIML type of a use case with a 400G network. Others may need an 800G or terabit network. It kind of depends on how their existing network architecture is laid out. You could have 2 lines of 200 to get you to 400 or you could have 2 lanes of 400 to get you to 800. It all depends on the internal architecture for these companies. So we see both 400G and 800G and terabit all driving and catering to the needs of the increased data traffic, which comes from use cases like AI ML. So short answer, we do see 400G manufacturing that will pick up again next year while we continue to see more R&D investment in 800G and terabit.

So if we just step back, maybe high level within the communications space, is it fair to say wireline has maybe not experienced the same level of near-term softness that the wireless business has? Or is it fairly balanced?

It's -- I would say we've had -- the decrease has been on both sides and primarily related to 100G and 400G deployments. So we do have exposure to optical components and switch manufacturing and things like that have taken a step back because of the inventory exposure. So we -- and some of our top customers have -- are scrutinizing their spend on some of their programs. So I would say it's been a bit more balanced. And we do see, again, use cases like ongoing revisions of 5G, nonterrestrial networks, new use cases. 5G is finally diversifying outside of the smartphone use case into these new industry verticals. So that on the wireline spend going forward.

Just around 5G then. So does the deceleration that we -- that you're referencing, has that then been more on the physical layer side, less in the application layer or protocol layer? Or how should we think about the various buckets within wireless 5G that's ongoing?

Yes. It would be -- while the deployments are continuing, it's a little bit slow. That's the piece that you could say is -- has slowed down a little bit. But then the new use cases are continuing to expand, nonterrestrial networks, industrial IoT, RedCap, things like that. You've got application layer expansion going on in automotive and aerospace defense. So we see that aspect of 5G pickup. Standards-based evolution, 5G advanced, incorporating AI/ML in 5G. These things are seeing R&D investment. The number of frequency bands continue to expand. It's now in the tens of thousands. So test cases associated with that, we see spend with that. O-RAN deployments have not taken a step back. In fact, regional lower end point and it's going to lead to more improvements in the core network, which will address use cases like AI ML and 6G research is continuing. So we see many of the long-range R&D spend vectors continue while the short-term impact has been largely in component manufacturing, et cetera, related to the smartphone use case.

So as these new releases come down '17, we'll look out to '18, how is the demand materializing, I guess, vis-a-vis what the customer profile looks like? The products and solutions that you're providing into the demand, how it differs or does it differ from what you supplied early on in the 5G phase? Is it more software orientation? Do you still need the hardware platforms to be deployed into those new customers? Just a little bit on what the profile looks like as we go forward.

Yes. So it's a good question. And the answer, it depends. I mean, if you look at something like a nonterrestrial use case, which involves satellite connectivity, that's a whole new ecosystem. So you have new customers coming on board, and there are new solutions, including hardware, that's required. So you could say that, that's a new portfolio or an extension to our 5G platform with new customers, something like RedCap, which caters to IoT use cases versus the smartphone. That could, again, attract a whole set of customers. Somebody doesn't have to make a smartphone, but they could make a module that's catering to some use case in a different industry vertical. So that could be new hardware in the new customer base. So we see the evidence of that. Then you have ongoing improvements in smartphone use cases, the dual SIM, dual standby use case or frequency band extension, improvements to battery performance, things like that. In the standard, that would be more of a software upgrade to some of the existing customers. So it kind of varies based on the use cases. But suffice to say that 5G -- the promise of 5G is to cater to these multiple use cases. And over time, we do see the number of customers expanding even in the previous -- even during this first half, the number of customers that we've had has been stable. And actually new customers have been growing while the spend from some of the top customers have slowed down a bit.

You mentioned satellite in that remark. Space in general seems to be getting a little more commercial space or space in general seems to be getting a little more mentioned, Neil in some of your commentary and just on the quarterly call, just can you just -- is that moving up in terms of the level of importance in that aerospace defense segment?

Absolutely. I mean, and it's -- the exciting thing about this is we've been in this business -- we've had a portfolio for decades, primarily targeting at aerospace defense use cases. Now we see the expansion in aerospace defense, but also in the commercial space application with the LEO satellites and so forth. What's interesting is the government entities want to have the current legacy satellite networks interface property and interoperate with the new commercial networks and including the new technologies like 5G, nonterrestrial network. So there's opportunities in user terminals. There's opportunities with ground stations. There is opportunity just with the satellite design and manufacturing, channel modeling, and we have an end-to-end portfolio that addresses all of these use cases. Advanced telemetry systems, modeling of channels, new acquisitions we've done like SCALABLE Technologies. It's a small acquisition, but it adds a digital twin portfolio to model some of these networks and that we've been able to use to augment our 5G platform. So overall, we see this as a positive trend. I mean, there's -- there are industry [indiscernible] market research reports that says that this business -- the satellite market in general is growing double digits over the next 7, 10 years. So we're excited about it. We have both a portfolio from a commercial standpoint as well as from an aerospace defense point of view to participate meaningfully and have a strong position in.

Indeed. Maybe shift real quick just to the automotive business. Again, continues with very good momentum. Just kind of talk about the breadth of demand that you're seeing in automotive, it seems maybe a little more weighted to EV. I'm not sure if that's the case. We're talking about that more. But on the ADAS side as well, how you're serving that? If there's still any -- because it's still a relatively new evolving market, new market. If there's any gaps -- product gap solution gaps that you're looking to fill?

Yes, I'll start, and then I'll let Kailash add on. I think -- and it's certainly true that the most immediate sizable opportunity that's in front of us sits on the EV side of things. And so while there is a work that's happening, the big demand driver right now is the electrification of the drivetrain. And we see that playing out not just in the big auto OEMs around the world but through the Tier 1 supplier base as well. I think we continue -- I'll let Kailash talk about the autonomous drive opportunity here in a minute. But I think beyond that, we do continue to see opportunities for us to bring in new technologies to round out our portfolio. We've done some small acquisitions in the space recently about a company called [indiscernible]. There's is a company called Varisco bringing in small software applications that we can layer into our portfolio to increase the software content in the auto space. And then do you want to talk a little bit about autonomous?

Yes. I mean AV is, again, an interesting space. When you look at all of these new vehicles, I mean the chip footprint, the electronics and the wireless footprint are continuing to expand. I mean things like satellite connectivity, we have OEMs contacting us or how to integrate satellite connectivity into all cars of the future. So these are use cases. Lots of sensors, automotive ethernet because some of the legacy canvas technologies are getting replaced with automotive Ethernet. So clearly, technologies that we've developed for commercial [indiscernible] for chipsets, for wireless. And in the future, 5G satellite connectivity, automotive Ethernet, I mean, these are all vectors where we see growth in autonomous [indiscernible]. That's -- it's not just that some of these OEMs have factories where things like private networks are going to be used in the future to automate things in their factories. So that's an opportunity for us to participate as well from an enterprise private network perspective, especially with automakers. So excited about what AB and some of these additional vectors can bring in. But right now, it's all about EV growth.

We did have one question come in. I'll go ahead [indiscernible] insert this into the conversation. But the question was, is -- iPad goes dark on me. But the -- what makes you capable of capturing 100 basis points of share per year? Or where do you gain the confidence in that?

Yes, I'll start and I'll let Kailash comment as well. I mean -- but I think we're in a unique position given the breadth of our portfolio relative to other players in the industry, I think we have -- because of our scale, we have an ability to invest in R&D applications or an R&D at a level that others have a difficulty to match. And I think the broad range of end markets that we serve and the way that we are using our tools in combination and adding software capability to address the fundamental rather than just providing tools to these industries, but really looking at the fundamental problems that they're trying to solve and how all of Keysight Technology -- Keysight's technologies can be used in concert to help solve those fundamental problems, I think, is allowing us to outgrow the market.

Yes. And we've kind of talked about this at our Investor Day. We're really looking at the company as an innovation enabler -- as a workflow enabler for everything from simulation, all the way to live deployment. And as Neil pointed out, is to continue to invest in R&D and determine what it takes to win these next cycles.

I think, Kailash, a manifestation of that. In my view, it was mentioned at your Investor Day as well, you have 500 or 500 or more Keysight employees that are effectively embedded at your customer sites. That's -- how unique is that? What advantage do you gain from having employees that deeply into the customer set and differentiator [indiscernible]

Yes [indiscernible] Engagement [indiscernible] Again, shifting left, having a lot of the R&D folks. These are not folks that are providing support or application level integration. These are folks from our R&D teams engaged with customers co-innovation. And that is unique. It's not something that our customers take likely or we take... [Audio Gap]

The value that we bring to our customers and look to make sure that Keysight as a firm is getting compensated for that value delivery. I think across the portfolio, there's -- there are places where the solutions are more differentiated than others, and we work very hard to understand that and to price our products accordingly. And I think as I've just talked about, we have [Audio Gap]

[indiscernible] Certainly as things are more challenging right now, maybe minimum level of volume growth that would need to occur to be able to achieve those over the time period [indiscernible] target 5% to 7% over the long period?

Yes, we targeted this mid-single-digit kind of levels of revenue growth over the cycle. And obviously, we're in a period of time right now where demand is under pressure, and we're not hitting [Audio Gap]

[indiscernible] There is a breakout session afterwards in Astra A, and I want to thank Neil and Kailash for joining us.

Great. Thank you Rob. Appreciate it.