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

Everybody can go ahead and please take their seats. We're going to go ahead and get started with the next session. Thanks, everyone, for joining us. For those of you who don't know me, I'm Matt Niknam, comm infrastructure, networking and hardware analyst here at Truist and we're very pleased to be joined by Keysight Technologies. We've got EVP and CFO, Neil Dougherty; as well as SVP and President of the Communications Solutions Group; Kailash Narayanan joining us. Thank you for being here.

Thank you. .

So maybe just to start from a high level, Keysight is the market leader in test and measurement. You recently described yourself as a design enablement partner across the full innovation life cycle. So for investors who may be newer to the story, how would you define what Keysight actually does today from a high level?

Yes. Why don't I start and I can let Kailash add on. I always do, if I was describing it to my mother, I would say that at the highest level, Keysight provides tools, hardware and software tools and solutions to industries that employ electric in at a fundamental level, that's what we do. And so right now, that's being driven by the wireline ecosystems that they add data centers, specifically the migration soon right now from 5G to 5G advanced, but soon to 6 advancements in aerospace, defense, broader electronics ecosystems, autonomous driving and semiconductor advancement are kind of the big industries in which serve. And we serve those industries again, primarily in the R&D lab more than half of our revenues come from sales into our customers' R&D labs where we're enabling the design ecosystem from measurement of core physical layer measurements all the way up through protocol layer and application layer software solutions. And then also in solutions and manufacturing, testing, electronics at the end of the manufacturing line for functionality. -- and then a smaller portion of our business in kind of operational or post-deployment type applications. So I don't know if you want to add anything to that, but.

We'll pivot to Kailash's domain. So Communication Solutions Group, it's about 3/4 of sales, Keysight, 2 different businesses. You've got commercial comms. You've also got aerospace defense. Can you walk us through what sits under you? How the organization structured in your top priorities as you head into fiscal '27?

Yes. Well, it's a good time for Keysight. It's a good time for the Communications Solutions Group business. So as you've identified, we have the commercial comms business and in the aerospace and defense business. while it might sound like a different business, yes, they are serving 2 different end markets, but a lot of the solutions that we build is driven by common R&D and is applicable to both markets. So I want to say that. I have these 2 business segments are externally reported. Within commercial communications, we break it down into wireless and wireline we have organizations and multiple vice presidents running those entities. We serve customers from chipset players, both in the wireless and wireline space. Think about the I think of the Intels and the Qualcomms and the NVIDIAs and the Broadcoms and the Marvel and so on and so forth, you have makers. Think of the Samsungs and the Apples of the world, you have network equipment makers, the Ciscos, the Junipers, the Ericssons and the Nokias the contract manufacturers, mobile network operators, hyperscalers, satellite network operators. So this is sort of the business that commercial communication spans then we have within aerospace and defense, we have multiple segments, space satellite, radar threat emulation, general comms. So I've got multiple VPs covering that. My group is responsible for everything from technology investments, capital allocation that we need to make for core technology development as well as products. we're responsible for coming up with the product strategy, the products and the solution road maps, how it Intercept's market windows. My team also leads the product engineering. So engineering sits under me. So all the launches were responsible for to intercept the market windows of our key customers. And we have sales enablement and business development functions that work in concert with our global sales organization to take these products to market and serve our our end markets.

And so maybe just to sort of broaden the question. In terms of top priorities for you both, as you sort of close out fiscal '26 and head into fiscal '27? If you can maybe outline high-level priorities.

For me, the key things, obviously, we are looking to sustain the momentum that we have established over the last couple of years. in AI, the speed transition to 3.0 is starting to occur. There's quite a bit of R&D activity in silicon photonics, co-packs, optics and so forth. So it will be important to sustain that. from a 6G and a wireless perspective, things will start to ramp towards the end of next year and into 2028, getting ready for that inflecting market is going to be important. That's a key priority. And of course, in aerospace and defense, we see expansion in EU. We see expansion in the Americas. We see this new emerging ecosystem of defense technology start-ups so that's an exciting application and the market segment for us to capitalize on. So those are probably the key priorities for me.

Yes. I mean as I think about it, I think about particularly over the short horizon that you've talked about is how do we maximize our capture of the market opportunity that's in front of us. And so when I think about it through that lens, I think there are a number of things that we need to do. First of all, we need to continue to execute on our R&D programs to make sure that get those products to market at a time that intersects the needs of our customers increasingly right now, it means that we're managing supply chain, both in terms of ramping up our own internal capacity as well as working with our suppliers to ensure the supply that we need to convert robust demand into revenue on a short horizon. It's working with our sales force on tactical issues around, again, intersecting this market opportunity and making sure that we're selling high in the organization's VP to VP level connections at market-making customers that we're not missing any opportunities that were out there doing the hunting for opportunities and finding the opportunity so when you talk about that short horizon, I come down to core execution around intersecting this market opportunity and really maximizing our value capture over that short horizon.

So obviously, execution against a very strong market backdrop, you've had orders now that have grown 50% roundabouts organically, the second straight quarter. you've discussed a still very robust pipeline. So can you help us think about how much of the improvement is Keysight specific in terms of new products, go-to-market changes relative to just the end markets that are simply spending more.

Yes. I mean I think both of those things are working in concert with another, right? Certainly, we're being aided by a very strong market. But if we weren't executing and we did not have a differentiated product portfolio, our ability to intersect that robust market demand would not be what it is today. And we are benefiting right now from decisions that were made 2, 3, 4 years ago, when we first recognized this transition that was happening in the AI space and the investments that we made over that period of time to have the product portfolio, the solutions portfolio that we have today. . And so I think those 2 things go hand in hand. I think we have a very differentiated portfolio in the marketplace. I think we are doing our best to work at the same pace that our customers are working at and keeping in mind that these design inflections or these technology inflections, the time between them is compressing, right? And so there's a need to work at a very rapid and increasing pace, and I think we're succeeding in doing it. I don't know if you have anything to add.

Yes. Maybe just an example of how those R&D investments are translating into key products that the market wants the data center builder is a product that we launched about 18 months ago. It's there is no precedent for that type of a product. And by engaging with these market-defining customers, we were able to identify an unmet need which was essentially to allow them to benchmark all of their AI infrastructure. It's a multi-vendor infrastructure that they're deploying in their data centers, and they need to benchmark. They need to see how many tokens per second are you able to deliver with a certain rack or with a certain cluster, what kind of network topologies work what is the energy consumption of different types of hardware that they're implementing in their data centers. And this is a product that that we came up with, there wasn't any in the market up until that point. And we're seeing a lot of traction for those types of products, right? So it's all the investments that we've made over the last several years non-terrestrial networks is another application. So pretty excited about where we are. So why don't we go down the AI path? The wireline revenue exceeded wireless for the first time, I believe, this past quarter, and you framed the AI opportunity around 4 pillars. There's infrastructure scaling speed transition, silicon photonics and system-level emulation. Which of the 4 pillars is maybe the most the largest, most material today? And how does this evolve over time I mean all of these pillars are, at the moment, generating revenue for us, generating business for us. But maybe before I get into that, at the highest level, our customers innovation cadence is increasing. The number of product SKUs that our customers are building and developing is just it's unprecedented that innovation is driving a lot of investment in key solutions and products from us. The complexity of what our customers are doing is also increasing going from 100 gig to 200 gig per lane to 400 gig per lane drives enormous complexity in terms of the design considerations that customers have to customers have to factor. I mean you think about coupling interference losses, signals are not traversing just 1 PC board, multiple PC boards, interconnects, cable assemblies and so on and so forth. So all of this is driving complexity. And our customers are deploying all of this at scale at the same time, right? So it's not just they're investing in R&D. -- but they're deploying it at scale, which is driving solutions in the manufacturing application. So if I look at those 4 things, the speed transition is very important. It's playing out now. 1.60 is gaining a lot of traction. -- we're leading in that space. And we expect that to continue next year, and there is a 3.2 R&D that's already underway. And as you go into higher speeds, silicon photonics, there's quite a bit of R&D investment that's going on there. So that's occurring. -- everything as -- when it comes to system simulation, everything doesn't necessarily -- it's not only that it needs to be tested in isolation or validated in isolation you have to look at how these data centers and these clusters work together. So if you're trying to deploy a chip -- it could be a network chip, it could be a GPU, it could be a compute tray. -- you're deploying into a data center, you need to see how it performs in the context of multiple racks and multiple data centers. So that's driving a lot of demand for our system-level emulation. And as I mentioned, all of this is getting deployed at scale, which is driving manufacturing. So at this point, I would say speed transitions and system emulation is driving a lot of today's business and of course, the AI expansion, silicon photonics, still in the R&D realm, and that's something that we would expect to scale over the next several years.

Yes. Got it. I want to hit on a little bit more in terms of AI and the wireline conversation. Hyperscalers today, I believe, were framed in terms of direct exposure, roughly 10% of sales, but there's a lot more that they drive downstream. I think that was talked about a little bit on the last call. So with custom silicon proliferating, the stack is becoming a little bit more heterogeneous, -- how does that affect your business in your customer count. And maybe just secondarily to that, where do the frontier models and Neo clouds fit within that picture?

Yes. I mean, that's it's a good question. The hyperscalers direct business is a small percent of total revenue, they do drive multiple times that in terms of downstream ecosystem business. Our business is very highly correlated to the CapEx that is being deployed. Each of these hyperscalers have their own ecosystem. So when you look at a particular hyperscaler, you might have heard of this terminology MSA. This is the multisource agreement there's an alliance that's led by a hyperscaler or a leading chip vendor, and there is an ecosystem that's built around that. and they tend to specify the types of solutions that need to be used in the workflow. We engage our R&D teams, my engineering teams engage with hyperscaler engineering teams and every other member of that ecosystem directly in helping them drive that workflow. So it's not just 1 ecosystem. It's multiple ecosystems that's driving this business driven by a central hyperscaler or a or a chip manufacturer. Neo clouds and these frontier model folks are part of that ecosystem. It could be part of multiple hyperscaler ecosystems. They could be part of a single hyperscaler ecosystem, but we've seen our business grow with them as well and a number of players that are part of this AI business continues to expand for us.

When you think through AI network emulation, high-speed digital validation, you may just still play devil's advocate, what prevents a well-resourced hyperscaler from building that capability internally.

I mean that's sometimes that's always been the case, and it has happened in the past, and it still happens now in the margin. So our business that we have today and the growth that we have today is already factoring in and in the middle of those dynamics. But I will say that there is a couple of things. If it's completely if it's only software-specific, it's probably a little easier. But with the speed grades going from 100 to 200 to 400 to 800 million getting into silicon photonics and needing to emulate everything, not just simulate simulation, you can write a software program on PC, and you can do some of that some of that simulation. But when you need to when we talk about emulation, it's about doing it and emulating a hyper realistic environment. This is where we're differentiated. It requires a lot of hardware investment. And then that's where it may not be worth somebody's time to really invest in that. And we have exposure to the entire market, multiple hyperscaler ecosystem. So we're able to bring in a rich set of insights that might not be available to 1 segment. So those are things that are differentiating. And I mean, you also have to remember that it's in the hyperscalers ecos interest to enable an ecosystem. And when they enable an ecosystem, if they are the ones that are building the test solutions and so forth, they're going to have to support it. They have to keep up with it. And all of that -- if it's 1 or 2 players, they can do it. But if it's multiple players, it gets prohibitively expensive, and it's not core to what they're doing. So those are -- that's kind of where we have a unique offering and a differentiated play to the market. -- let's pivot to wireless. And I think if this were a decade or 15 years ago, we probably would have led with wireless, and we would have spent a lot more time. So it's nice to see sort of such a broadening in terms of end markets. But on wireless, so 3GPP has said, I believe March 29 for the first 6G standard. You've said customers are moving from exploratory research into more funded development programs. Can you help map the revenue ramp for us from 6G in terms of when you start to see test spend inflecting and how the shape of that maybe ramp compares to the 5G cycle? As you pointed out, we are seeing that funding transition from research institutes, universities into funded programs. Our customers are now involved in product research and early product development. And we're seeing traditional players, the network equipment makers, the device and the wireless modem makers all start to gear up for commercialization in late 2029 and into 2030. And our 6G wireless business has been growing steadily. It grew again this year. And we expect to see this in fact in the first half of 2028 in readiness for the Olympics. There may be some pre-standard showcasing of 6G technologies. Throughout next year, there's going to be a steady cadence of engagements and investments as well. So we're engaged with all of the leading customers. We're seeing new players from a non-terrestrial networks perspective. So I would expect the shape to be fairly similar to 5G. 5G was commercialized in 2019, 2020. So were these generations happen once in 10 years. So that's -- and we're leading up to that. So that's sort of how I expect us to evolve. There are newer applications for short. -- in addition to the traditional smartphone type of use case. You have integrated sensing and communications you have nonterrestrial networks. So those might add some modulation to the shape of the market and how it evolves but those are all net additive to us. That's sort of how we see it. And so among you mentioned ISAC, you mentioned nonterrestrial networks. I think there's an invention of AI RAN as well. Which of those -- I mean, is there any 1 of those that maybe expands your addressable content the most and maybe gives you a little bit more incremental opportunity? Like what gets you excited among those? I mean all of them are unique and are pretty exciting. And all of those applications expand our opportunity. When you think about application of AI to help with the RAN network. I mean this is about customers deploying AI algorithms and testing those algorithms for not just regular network and mobility functions, but energy efficiency, traffic steering, beam forming, scheduling, all of this. And we provide an emulated environment to help validate those algorithms. You also have to see how AI traffic and the regular network wireless traffic coexist, how it degrades the performance of the network. All of this requires a new validation new emulation that customers have to perform in their lab. So that's pretty exciting. Integrated sensing and communication, again, a new additive opportunity, you need to now all all new devices outside of smartphones, whether they're flying objects or whatnot, have to be sensed you have to be communicated with. They need to be controlled. They need to be maneuvered -- they're going to be connected to satellites and base stations and other devices, again, creating more opportunities for us. nonrenew is a pretty exciting number of constellations going up, a number of frequency bands going up. number use cases, broadband use cases, direct-to cell connectivity going up. So that's expanding our opportunities as well. If I were to pick 1 that is driving we're generating business in all 3 of these use cases now, but something that's more commercial now is nonterrestrial network. So that's a driving business for us and and the rest we expect to gain traction over the next few years.

Let's pivot to the other piece of CSG. On aerospace, defense, and I'll open it up to both. That segment grew about 14% last quarter. It's about 1/4 of the CSG business. Can you talk about how much of the multiyear cycle that you've talked about is European sovereign budgets relative to U.S. modernization? Because it seems like there's a lot going on in terms of long-term tailwinds. Maybe we could just parse through some of the drivers you're seeing for that business?

You look at -- it's all of that, right? I mean, our U.S. business has expanded strong double digits. You -- it's a pretty big base. We're seeing the large primes continue to spend. The defense budgets, obviously, has gone up. The research and development portion of the defense budget is also going up. That drives a lot of business for us. EU is growing even faster but it's on a smaller base, and we expect that to be a multiyear secular trend. We're building more capabilities over there to enable those applications -- and then you have these defense technology start-ups that I alluded to earlier. It's a new emerging economy, if you will, within the aerospace and defense space, they're not dependent. These companies are not dependent on government budgets. There are product companies VC-funded and they're moving kind of at the pace of Silicon Valley companies. So it's a new set of opportunities, and it's almost a slightly different pool of capital that we're able to tap into. So all of these are driving business. The LEO from an application point of view, it's new satellites, it's coexistence of commercial satellites versus custom purpose satellites or other purposes. -- general communication infrastructure, cybersecurity, thrust simulation, the portfolio that we added from the Spirent acquisition, position, navigation and timing. That is driving a whole set of new use cases. So we feel like not only are there tailwinds from a market point of view, but the portfolio that we have in the portfolio we've built is enabling us to capitalize on that growth.