是德科技 (KEYS) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Second Quarter 2017 Earnings Conference Call.

My name is Heidi, and I will be your lead operator today.

(Operator Instructions)

Please note that this call is being recorded today, Tuesday, June 6, 2017 at 2:00 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 2017.

Joining me are Ron Nersesian, Keysight President and CEO; and Neil Dougherty, Keysight Senior Vice President and CFO.

Joining in the Q&A after Neil's comments will be Mike Gasparian, President of the Communications Solutions Group; Gooi Soon Chai, President of the Electronic Industrial Solutions Group; John Page, President of the Services Solutions Group; Bethany Mayer, President of the Ixia Solutions Group; and Mark Wallace, Senior Vice President of Worldwide Sales.

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.

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.

I would also note that management is scheduled to present at the Credit Suisse Semiconductor Supply Chain Conference on June 13 in Boston.

And now I'd like to turn the call over to Ron.

Thank you, Jason, thank you all for joining us.

As I am traveling internationally today, I will keep my formal comments brief and focus the discussion on 3 topics.

First, we achieved a strong second quarter that was substantially ahead of our expectations, and we are pleased with our execution and results.

In total, we delivered 6% order growth, 3% revenue growth, 19% operating margin and 5% earnings growth.

Second, we continued to build momentum with our key growth areas.

We achieved record orders for 5G, including a significant win with Qualcomm, as we announced in a press release this morning.

We also had record orders for our modular and automotive and energy solutions.

We believe our continued progress demonstrates that our strategy is working and our transformation is well underway.

And third, we closed the acquisition of Ixia in April, which was ahead of our expected timeline, as we efficiently obtained financing and cleared all necessary regulatory approvals.

We are thrilled to officially have the Ixia team onboard and now focus our joint efforts on the integration, innovation and increased value creation.

Let's begin with a review of Keysight's second quarter performance.

In addition to our strong total results that I just referenced, Keysight, excluding Ixia, delivered 4% organic order growth, 2% core revenue growth, 20% operating margin and $0.64 in EPS.

Taking a deeper look into our bottom line performance, excluding Ixia and the associated interest expense and share dilution from the acquisition financing, we delivered $0.67 in earnings per share, a 10% improvement over Q2 of last year.

The dynamics in our end markets remain relatively consistent with last quarter, as customers continue to focus their investments on next-generation technologies.

In our aerospace, defense and government end market, funding in the U.S. partially recovered off its soft Q1 to bring orders in line with last year.

In the growth segments of our markets, we continue to build solid momentum and finished the second quarter stronger than we had expected.

Our growth was driven by continued investment in next-generation technologies, including 5G, IoT, high-speed data centers, the electric car, autonomous driving and next-generation process technologies.

Our focus on bringing solutions to markets that help customers accelerate their next-generation designs across the communications ecosystem is allowing us to drive multiple avenues of growth across these trends.

To demonstrate our progress in capitalizing on these evolving trends, I will share with you a few highlights in the quarter that we find particularly exciting.

First, orders for our 5G solutions doubled over Q2 of last year to reach a new record, and we secured a significant 5G win with Qualcomm for our industry-first 5G protocol design solution that we just launched this quarter.

This solution enables developers the ability to seamlessly prototype designs as they migrate from pre-5G to 5G New Radio and address protocol layer design, an area of the market where we did not participate in 4G.

With our targeted efforts in 5G and our leadership in high-frequency technologies and solutions, we believe we have established a leading position in the 5G marketplace and are on a solid path towards our goal of being first in 5G.

Second, in high-speed data centers, we saw an increase in development activities for 400-gig PAM-4 and silicon photonics technologies, which drove demand for our recently introduced 64 GBaud bit error rate tester developed for electrical and optical PAM-4 transmitters and receivers.

Ixia has also taken a leadership role in 400-gig innovation.

Earlier this year at OFC, Ixia demonstrated line rate 400-gig Ethernet with PAM-4 electrical lanes.

Ixia is the first and only player in the market with this solution in the latest double-density form factor.

This first-to-market solution underlines why Ixia is the leader in the network test market and delivers continued proof of their technology leadership over the competition.

Third, in the automotive and energy market, we delivered a record quarter with strong revenue growth across all regions as the automotive ecosystem continued to grow at a healthy rate and Tier 1 suppliers expanded their design capacity.

The rapid electrification of vehicles and the move to autonomous driving is shifting this industry from mechanics to our areas of strength in wireless communications, radar and smart battery development.

We are gaining strong momentum with leading customers in this evolving industry and growing ecosystem.

Notably, in the second quarter, we added 10 key new customers.

Our expanding customer base in this end market includes top-tier automotive makers as well as specialized automotive electronic module producers, chipset vendors and energy component and battery producers.

And lastly, we achieved another quarter of strong growth in next-generation processing technologies, where we have a leading position in parametric test.

In the back half of the quarter, new investments in the buildout of capacity in China drove higher-than-expected demand, which contributed to the upside in our second quarter results.

Our leadership in this end market, coupled with our record performance in automotive and energy, resulted in 14% year-over-year revenue growth for our EISG segment.

In summary, we are very pleased with our second quarter performance and continued steady progress of building multiple avenues of growth across a diverse set of end markets where customers are investing in next-generation digital and electronic technologies.

We are confident that we have the right strategy in place.

It is working, and our transformation is well underway.

Our strong innovation and solutions portfolio uniquely positions us for growth as these long-term trends continue to evolve and customers invest in next-generation technologies.

It is undeniable that the digital landscape is transforming and will continue to influence the way we communicate, drive, shop and even obtain medical care in the years to come.

Whether it is for high-speed data centers, next-generation mobile networks, radar, electronic warfare, automobiles or medical devices, Keysight Solutions go where the electronic signal goes, from design simulation, to prototype validation, to production test to optimization in the network.

Now with the acquisition of Ixia, which we closed in April, we have broadened our reach within and beyond these growth trends and the communications development life cycle.

Keysight reach now includes digital packetized data, applications, visibility and network security as well as electrical signals.

We are excited to add Ixia's deep bench of talent to Keysight's team, which will continue to be led by Bethany Mayer.

Our integration efforts are off to a great start, and we look forward to partnering on end-to-end development of next-generation technologies.

Together, we will expand our number of touchpoints with long-term technology trends in key customers and accelerate our growth.

With that, I'll turn the call over to a Neil for a detailed review of our financial performance and the third quarter outlook.

Thank you, Ron, and hello, everyone.

Today, we reported second quarter GAAP revenue of $753 million, which includes 13 days of revenue from Ixia; and non-GAAP revenue of $758 million, which excludes the impact of the acquisition-related fair value adjustment to Ixia's deferred revenue balance.

Core revenue, which excludes the impact of currency and revenue from acquisitions completed within the last 12 months, grew 2% year-over-year and was ahead of our updated guidance range.

Regionally, core revenue declined 1% in the Americas; 3% in Europe and 5% in Japan; while in Asia, excluding Japan, core revenue grew 10%.

Looking at our operational results.

Gross margin was 59.0%, a year-over-year increase of 120 basis points, driven by favorable product mix, with a higher contribution of software and EISG solutions.

Operating expenses totaled $300 million, a $10 million increase over the same period last year, reflecting Ixia expenses for the partial period.

Excluding Ixia, year-over-year operating expenses were flat, demonstrating our ongoing operating model discipline.

This resulted in second quarter operating margin of 19.4%, up 110 basis points when compared with 18.3% last year.

We reported net income of $114 million or $0.64 per share.

Excluding Ixia and the associated interest expense and share dilution from the acquisition financing, which was not in our guidance, we delivered net income of $116 million or $0.67 per share, which represents approximately 10% earnings growth versus the second quarter of fiscal year 2016.

We ended the quarter with a weighted average diluted share count of 179 million shares.

Moving to the performance of our segments.

Our Communications Solutions Group or CSG includes 2 primary end markets.

First is the commercial communications end market that reported revenue of $256 million compared to $257 million in the prior year second quarter.

Growth from 5G and next-generation data center technologies was offset by soft spending in wireless 4G.

CSG also includes our aerospace defense and government end markets, which generated revenue of $168 million in Q2 compared with $189 million in the same quarter last year.

As we mentioned on our last quarterly call, our aerospace defense and government end market was impacted in Q1 by soft spending in the U.S. due to delayed budget approvals.

A federal budget with increased funding for defense was approved by Congress in late April, and we did see a partial recovery in Q2 order results.

However, it is difficult to predict exactly when the flow of funding will return to a steady state in this end market.

Over the long term, we remain bullish on both our market position in aerospace defense and the prospect for increased defense spending in the U.S.

Total CSG revenue for the quarter was $424 million compared with $446 million in the same quarter last year.

CSG reported gross margin of 61.3% and operating margin of 17.6%.

Our Electronic Industrial Solutions Group or EISG generated second quarter revenue of $220 million, up 14% from the same quarter last year and a record high.

Semiconductor Measurement Solutions and automotive and energy solutions both posted strong growth, which was partially offset by a decline in the broader general electronics market.

As we noted last quarter, we've had several quarters of very strong growth in semiconductor measurement solutions, and we expect this to moderate somewhat as we move through the remainder of the fiscal year.

EISG reported record revenue gross margin of 61.8% and operating margin of 26.1%.

Following the completion of the acquisition of Ixia on April 18, we created a new operating segment named the Ixia Solutions Group or ISG.

The reported second quarter results for ISG cover the 13-day period between the closing of the acquisition and the end of our fiscal quarter.

During this time, ISG generated revenue of $12 million, gross margin of 77.1% and an operating loss of $2 million.

While Ixia was not required to and did not perform a hard close of its first quarter, which ended on March 31, I'll provide some color on their order performance for that period.

Ixia orders of $128 million were in line with expectations and up 4% year-over-year.

Orders for Ixia's visibility solutions grew 18% year-over-year and were 28% of total orders.

Ixia's test solutions order performance was in line with the prior year's first quarter but contained a higher mix of service and subscription orders, which are recognized as revenue over time.

Please note that we do not intend to provide Ixia's order performance on a go-forward basis, but will be reporting their financial results as a separate operating segment.

As Ron mentioned, our integration efforts are off to a great start, and as our integration plan has solidified, we are able to update our cost synergy timeline.

We now expect to achieve annualized run rate cost synergies of $40 million by Q3 of next fiscal year and remain committed to delivering the full $60 million of cost synergies over time.

Moving to the Services Solutions Group.

SSG generated second quarter revenue of $102 million, a 6% year-over-year increase.

Revenue growth for SSG was driven by an increase in sales for our remarketed solutions and calibration services.

SSG reported gross margin of 40.9% and operating margin of 16.2%.

Moving to the balance sheet and cash flow.

We ended our second quarter with $983 million in cash and cash equivalents.

Our cash flow from operations in the quarter was $49 million, which included $60 million in acquisition-related operating cash utilization.

Capital purchases were $17 million in the quarter, resulting in free cash flow of $32 million.

We ended the quarter with $2.2 billion in long-term debt, up $1.1 billion from the prior quarter, which we used to fund the Ixia acquisition, along with equity raised in the quarter.

We were able to take advantage of strong credit markets and issued $700 million in senior unsecured fixed-rate notes, with a coupon of 4.6%.

On the equity side, we raised $444 million in net proceeds by issuing approximately 13.1 million common shares priced at $35 per share, which includes the over-allotment.

Before moving to guidance, we would like to discuss a few modeling items.

First, we will continue to report revenue on a GAAP and non-GAAP basis, with the difference being the impact of the fair value adjustment to the acquired deferred revenue balance from Ixia.

Based on preliminary purchase price accounting, the net deferred revenue balance inherited from Ixia is $44 million, reflecting an approximate adjustment of 70%.

Second, we currently expect interest expense to be approximately $24 million per quarter.

Third, regarding our go-forward tax rate, we are in the early stages of planning how best to bring Ixia and Keysight together from a tax perspective, but for the immediate future, we are continuing to model a 17% non-GAAP tax rate on Keysight's profits and a 30% non-GAAP tax rate on Ixia profits, which yields a combined rate of approximately 19%.

And lastly, we expect our weighted diluted share count, exiting fiscal year 2017, to be approximately 188 million shares.

Turning to our outlook and guidance for the third quarter.

We currently expect Q3 non-GAAP revenue to be in the range of $840 million to $880 million, representing 2% core growth at the midpoint.

We expect third quarter non-GAAP earnings per share to be in the range of $0.51 to $0.65, or $0.58 in the midpoint, based on a weighted diluted share count of approximately 188 million shares.

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

Thank you, Neil.

Operator, will you please give the instructions for the Q&A?

(Operator Instructions)

And your first question comes from the line of Richard Eastman with Robert W. Baird.

Perhaps, Neil, or I don't know if Ron wants to take this one from a distance, but I'm a little bit curious.

The core order number -- so excluding Ixia, the core orders were up like 14%, which feels strong seasonally from Q1 to Q2.

It seems like it's 3, 4, 5 points stronger than normal.

And I'm curious which product lines perhaps you're seeing that strength.

Is it a continuation in the parametric test area?

Or maybe you could just kind of address that.

Yes.

So Rick, first of all, I checked your -- I don't know if we misstated something or if your math is wrong.

We have core orders up 4% in the quarter, not 14%.

Obviously, we saw strength in 5G.

We saw strength in modular.

We saw great strength in automotive, semi, were the strong points.

We saw weakness in 4G.

While aerospace defense was significantly better than it was in Q1.

It was below average growth rate for Q2 orders as well.

Well, I'm kind of talking seasonally, Neil.

So in other words, from Q1 to Q2, I thought the core order number was 7 91 in core, and you did 6 95 in the first quarter.

Typically, you see barely 10% sequential order improvement.

I'm just curious, is that...

Yes, okay.

I'm with you.

I got you.

I got you.

So if you look sequentially, one of the big drivers of the sequential growth then was aerospace defense.

We'd seen a 20% decline in aerospace defense orders in Q1 of last year.

Now it's year-over-year, right?

Year-over-year Q1 aerospace defense was down 20%, whereas in Q2, the numbers were closer to flat or was actually very slightly up on a year-over-year basis.

And so the sequential improvement in aerospace defense was a significant driver of the increase.

I see, okay.

And then just as a follow-up.

Within the electronic and industrial, the IESG (sic) [EISG] segment, the operating leverage that you delivered in the quarter, and again, I'm -- whether it's year-over-year or incremental, pretty significant.

And is that mix in that segment?

And I'd kind of flag again maybe the semi test business.

But is it -- is the incrementals there a function of mix?

Yes, that's correct.

Obviously, we saw really strong orders and revenue from our semi business, and that does tend to have a favorable mix impact in terms of the margin incrementals that we can deliver, so you're absolutely correct about that.

Okay.

And then lastly, and I promise no more, but there was some conversation today around a conference presentation, really, from Gigamon.

And they were speaking to some aggressive pricing by Ixia from time of announcement of the deal to close of the deal.

And I guess, what I'm just asking is as we look forward, we'll all use our own revenue number, but is it fair to use a gross margin number for projecting Ixia, say, between 77 and 78?

Is that...

Yes, that's fair.

That is their historical gross margin level and that is the level that we would expect to see from them going forward.

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

Ron, was curious if you could just elaborate on the aerospace and defense dynamics in the second quarter?

Directionally, you feel like the worst is behind us as far as the U.S. order trajectory?

Well, yes, as Neil had mentioned, we saw about a 20% decline in the first quarter, and in Q2, orders were up about 1%.

So although it didn't flush through on revenue, wherein Q2, revenue was down because of the Q1 orders, we did see the Q2 orders flatten out, and that's nice.

A little hard to tell what is going to happen in the budget cycle, but we are -- we look at the number of wins that we get and our position in the aerospace defense market.

And we are positioned very strongly in that space, and we're very confident with where we -- how we will turn out on a competitive basis.

As far as when the budget will jump up to the next level, it's hard to say.

We did say there were 3 ways in which the budget, or we could say, that orders and revenue could increase.

One was to get rid of the continuing resolution.

The second was an increase in the overall aerospace defense spending, where Trump was talking about $54 billion at one point, but (inaudible) up any amount.

And the third was by mix being more slated towards high technology, which we strongly believe will be the case, due to a little bit more of a slowdown of new programs over the past 8 years.

So we still look forward to those 3 upsides, but as far as the timing, it is a little unsure.

But we're ready for it as soon as the government starts spending.

Very helpful.

Then a two-part question for you, Neil.

Number one, was the Qualcomm contract win that you announced this morning included in your 5G orders in the second quarter?

And then number two, the services business grew about 7% core but lapped a pretty easy comp versus last year.

Is there any timing dynamic which you'd like to speak to there?

Yes.

So the Qualcomm -- a portion of that Qualcomm order, at least, was included in our 5G orders, so that is correct.

And in a minute, I'll let Mike comment on that Qualcomm win because I think it's significant.

Regarding the services business, as you referenced, we did have a relatively softer comp from a year ago, but I don't -- I wouldn't say that there's any particular timing that impacted our revenue stream here in Q2.

Mike, do you want to comment on the Qualcomm win?

Sure.

You could probably get the highlights from the release.

They've selected us for their new 5G network emulation solutions.

It's going to help them validate a lot of their RF workflows as well as the higher layers of their protocol for 5G.

We've got a great, scalable solution that we announced earlier in the month going from sub-6 gigahertz up to 28, 39 gigahertz.

And we will do a great job of transitioning our customers from pre-5G to 5G NR to whatever the final standards are.

This is a pretty significant win for us from a number of perspectives.

First of all, the dollars associated with the win will grow as the 5G program grows at Qualcomm and expands.

Secondly, they're a big-time leader in chipsets, and that part of the ecosystem really plays the role of early adopter and frequently serves as a reference solution for device makers in other parts of the ecosystem.

So I think we're going to get some downstream leverage.

And perhaps, most importantly, I think this is a really big milestone.

It was about 3 years ago where Ron declared the growth initiatives for Keysight, and one of which was we want to win in 5G.

And I think this win at Qualcomm is tangible proof that we're on the right path.

I think we've established ourselves in a leadership position.

We have been and will continue to -- invest aggressively to win.

We've got collaborations all around the world with the market makers that we're leveraging.

And we're really well positioned to help our customers accelerate the commercialization of 5G, so it's a really exciting story that's starting to unfold for us now.

I'll add just another comment -- just a comment to what Mike had said.

First of all, what we have won here in 5G on this protocol solution, we did not win in 4G.

So this is pure incremental growth to us and Keysight being focused.

The way in which we did that was we wanted to bring together the capability of Keysight with the capability of Anite and the capability of AT4.

Obviously, we made those 2 acquisitions over the last few years, and the solution that we put together was by bringing the best of hardware and software into a complete solution from those 3 companies.

And that's what really made us a stand-out and puts us ahead of the competition.

So we're very, very pleased with the progress and with the contributions that those 2 previous acquisitions have made.

Your next question comes from the line of Vijay Bhagavath with Deutsche Bank.

Yes, my question is on 5G and connected cars as a test opportunity.

Help us understand how this opportunity, in terms of test solutions, gets divided among your peer group, for example, with different carriers and OEMs work with different set of tests suppliers.

Are these -- and customers dual, triple, multisource.

And where I'm coming from is it'll help us to understand in terms of, is there any lumpiness in purchases?

How much visibility do you have?

Will you have any pricing pressures like the service providers playing you off your competition and so on and so forth?

Yes.

So obviously, those 2 markets, the automotive market and the 5G market, are in 2 different segments.

So why don't I let Soon Chai comment first on how we see the automotive market unfolding, and then Mike can make some additional 5G comments.

So Soon Chai, do you want to address Vijay's automotive question?

Yes, okay.

So this is Soon Chai here.

I think, definitely, as what Ron has mentioned, these are truly exciting time for the automotive segment.

It's moving from a mechanical business industry to electronic content industry.

And if you look at the car of the future, it's really all about electronic.

It's all about connectivity.

It's all about intelligent.

So this is (inaudible) plays very strongly to our strength.

Now our capabilities allow us to enable this major transformation in the automotive ecosystem.

We provide solution in multiple areas.

So firstly, we do design validation and testing of the critical automotive electronic control box or the ECU, okay?

Second is in the area of connectivity, we do solution for telematics, where we provide EDAS solutions such as radar package simulators, B2B connectivities.

And lastly, we also provide solution in the power management area.

Essentially, these are battery testing for EV and SUV.

So if you look at it, it covers a whole ecosystem from digital testing to telematics all the way to power management.

So we have built a good momentum of this segment and definitely, with a strong partnership with key customers.

Okay.

So that's really a little bit about the automotive area.

So with this, I will pass on to Mike to talk about the 5G portion.

Vijay, I'm not sure exactly where you wanted to go with this question.

I'll make some general comments about 5G and then maybe a little bit of insight about how we manage it internally.

From a 5G perspective, we continue to see acceleration of the 5G standards, most recently, the 3GPP committee pulling up 5G NR by about 6 months.

I'm sure you know about that.

That has -- and kind of in turn, it's got all the global operators and the NEMs gearing up for large-scale trials.

Depending on where you are around the world, different spectrum is being utilized below 6 gigahertz, sometimes 28 gigahertz, maybe 39 gigahertz.

So there's a lot of pressure on the chipset device companies from a manufacturing standpoint to be able to meet these new, aggressive schedules.

So that's why we've been working closely with our customers with all these collaborations and came up with this new 5G protocol R&D solution.

It's scalable to cover all the global spectrum that's out there, requirements.

And it's flexible enough to help people transition from wherever they're entering this technology wave.

It could be pre-5G, 5G NR, or eventually, what the final specs will be.

The other thing I'll just comment on -- because the way we're structured is with these industry solution teams -- so Soon Chai really has a great handle on the automotive and the industry -- and energy industry.

And buried within the Keysight structure, we have Centers of Excellence.

So we have a -- I manage a Center of Excellence for high-frequency measurements.

I also manage one for digital and photonics.

But for example, in the high-frequency measurement area, that group will have expertise in millimeter-wave technology, over-the-air testing techniques.

And those Centers of Excellence as well as our technology leadership organization or Keysight labs will be able to apply that and basically provide that technology to any industry.

So Soon Chai can draw on the Centers of Excellence from all around the company.

A great example might be 77 gigahertz in automotive radar.

The radar technology is primarily sitting in our high-frequency measurement COE, but it's accessible, too.

And we work closely with Soon Chai's industry group focused on automotive.

If I could quickly clarify -- and thanks for your explanation.

If I could quickly clarify.

Where I was coming from is if you walked into an AT&T test lab, would they have instruments from [NADI], from Keysight, maybe Rohde & Schwarz simultaneously for the same test use case or different test use cases will be from different suppliers, including yourself?

So that it helps us understand how they think of the test solutions providers in terms of use cases for these growth opportunities.

Well, I think there are a lot of different segments associated.

I might hand this over to Mark Wallace, too, to see if he has any comment.

He's our Worldwide Sales Manager.

But there's a lot of different segments.

Certainly, if you capture a win with Qualcomm, they'll develop a reference test solution for R&D that will really get handed off downstream probably to a device maker, which will then parlay into operators.

Now operators, depending on who they are around the world, are going to have different types of conformance testing.

And then you'll have -- you'll kind of go from the wireless device side to a base station side.

And so you could have different suppliers in different parts of the ecosystem.

Mark, do you have any additional comments there?

No, Mike, that's very accurate.

We do work with the test houses and have actively worked with them through our relationships over the last several years.

This is another area that Anite has brought a lot of strength to us, and we're going to continue to leverage that going forward.

But as you say, it begins at different points across ecosystem.

So as we're working early upstream with some of the chipset providers as well as the automobile manufacturers and some of the component suppliers, that leverage gets propagated across the entire ecosystem, including the test houses that you're referring to.

Our next question comes from the line of Toshiya Hari with Goldman Sachs.

My first question is on your Q3 guide.

If you could comment a little bit on the each -- the individual segments, how you view growth in the respective segments, that would be helpful.

Toshiya, this is Neil.

So obviously, we don't provide specific guidance for each of the individual segments, but I can touch briefly on kind of what some of the puts and takes are from a market perspective.

We obviously continue to see investment in next-generation technologies, 5G and automotive being 2 primary areas we would expect to continue to see strong growth as we move through the remainder of the fiscal year.

As we touched on, we've had a very strong first half of the year in our semiconductor businesses, as not only do you see a move to more advanced process nodes but the semiconductor buildout in China.

We are expecting some moderation of that buildout here in the second half.

Aerospace defense can be a business that's a bit difficult to call at this point.

On the positive side, we did see the budget get passed in April.

It did include incremental dollars for aerospace defense.

But we know, from historical data points, that it does take a while to go from the passage of a budget to the actual time at which dollars start to flow.

So I would expect aerospace defense to be soft again here in Q3, potentially starting to ramp in Q4.

And some of those dollars will continue to get -- the dollars in the current budget will continue to get spent even as we migrate into FY '18.

So that's kind of the puts and takes.

On the Ixia side, obviously, the visibility business, I would also mention, is another high-growth area.

And so we'd expect to continue to see strong growth in the visibility portion from Ixia as well in the second half of this year.

I think it is important to note, too, that as you start to think about the second half of the year and what's included in our guidance, obviously, we'll be adding the Ixia expense portfolio, particularly their R&D budget.

We're continuing to invest heavily in 5G.

And as we look forward, we expect that our R&D investment as a company now will be close to 15.5% going forward.

Great.

And then I have a follow-up on the commercial comm side of your business.

I appreciate the fact that you're very focused on 5G, and that's obviously the growth driver going forward.

But I was curious what kind of activity you're seeing in 4G.

Is it stable?

Is it declining?

And in terms of market share, are you picking up share?

Any color would be helpful.

Yes, so let me just make a really quick comment, and then I'll hand off to Mark Wallace here to add on.

Obviously, one of the themes that's been going on for several quarters in a row is the accelerated ramp-up of investment of our customers in 5G and a ramp-down of 4G spending that was happening faster than we had previously modeled.

But I'll allow Mark to make some more specific comments.

Yes, that's right.

So in Q2, we saw this occur.

Especially in Europe, we saw the decline in some of the year-on-year business as you compare it to last year for 4G drop off, substantially.

That's in both the test houses, conformance test as well as some of the 4G base station buildout.

So that was seen there.

And we saw it in other regions as well, a little bit in Japan, although we did see a little bit of recovery toward the end of the quarter with some of the component and supply chain part of the business.

So it's definitely a transition.

It's not gone to 0, but it's down quite a bit.

Your next question comes from the line of Krish Sankar with BofA Merrill Lynch.

I had a couple of them.

First one, is there a way you can quantify what percentages of revenues, either in the commercial comm group or overall percentage of revenues from 4G, from 5G?

And how much is auto as a percentage of total revenues?

Yes.

So we provide in our IR materials that are posted on our website a breakdown of our revenue across the business groups, and we do provide some level of visibility to the aerospace defense and commercial communications breakdown.

We don't provide a further breakdown of the Electronic Industrial business, its sub-segments.

I'm just flipping pages here real quick to get it in front of me here.

But you can find that data on our web.

So if you look at commercial communications, for Q2, it was about 34% of the total.

Aerospace defense was 22% of the total.

Our Electronic Industrial business, which includes general electronics, semiconductor and automotive together was 29% of the total.

Ixia, obviously, with only 13 days, was a very small sliver, at 2%.

And services made up the balance of 13% of total revenue.

Got you.

I was just trying to figure out if you can give exactly how much -- what percentage is 5G specifically or what percent is auto specifically.

No, we haven't shared those numbers specifically.

We did, in our proxy statement, disclose our 5G revenue for -- excuse me, our 5G orders for FY -- for last fiscal year, and so you could use that as a basis point from which to model.

And that's really done for competitive reasons, obviously.

These are highly competitive markets that are moving quickly and we don't want to share too much information.

Fair enough.

That's fine.

And then a little bit of a longer-term question.

I mean, I look 2 years out when 5G, you start getting the commercial deployment and standards definition phase.

Help us understand what is the opportunity for Keysight, both on the legacy Keysight business and also with Ixia because, I think, you didn't have much softer revenues during the 3G and the 4G phase.

But with Ixia, you probably have some incremental softer opportunity in 5G also.

So help us quantify what that number could look like.

And just as a quick follow-on to that, the Qualcomm, is that for legacy Keysight?

Or is there any Ixia opportunity in there, too?

Yes.

So let me just make a couple of comments, and then I'll hand off to Mike and, potentially, Bethany for some follow-on comments.

So first of all, the Qualcomm opportunity was a legacy opportunity.

I think, as you think about 5G moving forward, the nice thing about our portfolio is we really participate in the 5G ecosystem at multiple points, right, all the way from pre-R&D with our EEsof tools, as people are developing the chips and devices that they're going to operate in 5G: chips -- components, chipsets, devices, base stations.

And then all of that is ultimately going to drive a dramatic increase in data traffic back through the data centers.

And so there's an opportunity for not only our data center business and the core of Keysight, but Ixia to benefit from the 5G transformation.

So Mike, I don't know if you have anything to add to that.

I'll just make a really quick comment.

Even though the Qualcomm example that we've been talking about today is, in fact, legacy, as Ron pointed out earlier in the call, this was not a business opportunity we were able to pursue historically when 4G occurred.

It was really the confluence of the Anite acquisition and the AT4 acquisition.

They're bringing the protocol expertise into Keysight, combined with our RF expertise, has allowed us to have more of an end-to-end solution.

With that, I'll turn it over to Bethany to see if she's got any comments about Ixia.

Sure.

Thanks, Mike.

So for Ixia, we also have a very strong opportunity in 5G as well.

What we saw in the first quarter was a strong wireless quarter for us and double-digit sequential growth in wireless, primarily in Asia Pacific.

That's where we saw it.

But I would also comment that we do have several customers in other parts of the world looking at our products in 5G.

And then I would also comment that Qualcomm is a customer of Ixia's as well.

So we do have some nice complementary capabilities across Ixia and Keysight as we and the entire industry move toward 5G.

Your next question comes from the line of Stanley Kovler from Citi Research.

Just one more on sort of the 5G opportunity here.

When you look at the prior cycle that you had on 3G and 4G and understanding that now, you're talking about a fuller solution, what I wanted to understand is, given the way that 5G looks like it will play out, at first, it's going to start off as a fixed wireless solution and then dovetail into more devices or mobility type of deployment.

In the past, the peak cycle on 3G and 4G, in terms of spending, has lasted maybe 2 years.

Should we think about a similar cycle for 5G or thinking more about, like, a 3- to 5-year cycle on 4G?

And then I have a margin follow-up.

Yes.

So Stan, again, I'll make some initial comments and then hand it off to Mike.

Again, we think of these cycles as far longer than 2 or 3 years given that we really come in on the front end in the -- as we sell into R&D solutions.

And that's more true today in 5G than it even was in prior generations.

And so right now, here we are, we still don't even have 5G standards developed yet, and we have very strong engagement in 5G.

And so we do view these as far longer cycles than that.

Certainly, there's going to be a ramp as you start to look towards standards deployments, either in -- or standards definition, either in '18 or early '19 and then commercial rollout in the early 2020 timeframe.

But Mike, I'll leave it to you to add any additional commentary.

Yes, just a quick clarification on the model that you threw out.

First of all, I would agree with Neil's comment, and maybe Mark wants to add something in here.

I would view the peak 5G cycle as a much longer worldwide deployment than just 2 or 3 years.

The second thing, again, coming back to this worldwide dimension of the opportunity, fixed wireless is taking a very strong lead here in the U.S. with both Verizon and AT&T.

But if you look in the international markets, in Asia, in particular, most of the action is at sub-6 gigahertz and with massive MIMO as kind of a primary challenge.

So if you look across the different 5G deployments, you see over-the-air challenges, beamforming challenges, massive MIMO.

I mean, this standard really is a -- it takes it up a step-function on multiple dimensions, different frequencies, and it just leads to a plethora of measurement opportunities for us to make contributions, right?

It's largely unchartered territory, whether it's sub-6 gigahertz with massive MIMO or if it's a 28-, 39-gigahertz millimeter wave opportunity.

This is all new ground for our customers.

Mark, do you have anything else to add?

Mike, I would just add, to just build on what you just said.

Unlike 4G and, certainly, 3G, there's just such a larger breadth of opportunities that 5G is playing into, from the things that you mentioned to low-power, low-latency IoT applications, medical applications.

We talked about automotive and how these industries are colliding.

It affects the backhaul, the data centers.

So it's more than just pushing more through a wireless pipe.

It's more than just streaming Netflix.

It's about a whole number of different use models that are, first of all, completely global.

This is happening everywhere in the world, and it's touching all these different areas where Keysight is participating and being dominant.

So it's definitely more than a couple, 3 years.

If you think back from 2G to 3G to 4G, that was -- that occurred over a 20-, 30-year period, so I expect this to be longer than just that couple of years.

So if I could just follow up in terms of the gross margin outlook for next quarter.

If you back into the numbers, I land somewhere in the low 60s range if I'm correctly blending in the Ixia and Keysight margins.

And so that puts me above the range of where you've typically operated, obviously.

Could you just help us revisit how we should think about the gross margin line going forward?

Typically, you've gotten to these levels or near these levels at significantly higher revenue in the past.

Yes.

So obviously, we don't guide the individual line items, but let me make a couple of comments that might help you.

So first of all, you're correct.

Obviously, we're going to benefit from adding -- from a gross margin -- on the gross margin line, we're going to benefit from the addition of Ixia.

You're right.

We're adding, on an annualized basis, approximately $500 million of incremental revenue that has gross margin in the very high 70s in terms of where Ixia operates.

So that's going to be a net adder to Keysight who's traditionally operated in the high-50s.

Now within Keysight's portfolio, obviously, we have a wide range of margins, generally speaking.

Our sales into R&D, our customers' R&D labs come, with a higher gross margin than sales into manufacturing, certain product lines.

We talked about semi today having a favorable mix benefit from a gross margin perspective.

But I think if you look historically at Keysight's results, we've operated in a pretty tight band, a 2 to 3 percentage point band, and Ixia's been operating in a similarly tight band, albeit, roughly 20 points higher in total.

And so I think your math is more or less correct, and it's the type of thing you should expect from us as we move forward.

Your next question comes from the line of Farhan Ahmad from Credit Suisse.

Can you just talk about 5G?

We -- you talked about more than 100% growth in auto this year.

How sustainable do you think that is?

Secondly, you're getting a decline from 4G and a growth from 5G.

When do you think we get to a point that the 5G growth actually starts to become bigger than the decline that you are seeing in 4G?

Yes.

So obviously, we did put up triple-digit growth here, again, in 5G, and we saw very strong growth in 5G last fiscal year as well.

As for the sustainability, obviously, we're benefiting somewhat, the -- with the very early stages of a ramp, and so the numbers are still relatively small.

But we certainly expect that 5G is going to continue to ramp aggressively.

Now the growth rates are going to come down over time as the base goes up, but we're still at the very front end of a 5G ramp, still in a stage prior to standards developments -- or standards definition, and so there is an awful lot of 5G runway that is out there.

As you said, the 4G business is falling off and has resulted in a commercial communication segment for us that has been more or less flat last quarter, anyway, from an orders perspective.

And so what you're really seeing is 5G, next-generation data center technologies offsetting the roll off in 4G spending.

Mike, I don't know if you have any further comments on that.

Oh, no.

I just think it's obvious that at some point in time in the future, 5G is going to eclipse 4G.

I mean, that's not too hard to imagine.

So we definitely think that's going to happen, and exactly when, I don't -- I can't -- I don't think it's completely modeled out nor would we share it at this point in time.

But what I can say is our 4G sales, I think -- feel like they're stabilizing.

And so I don't think we're going to see dramatic falloff from this run rate, and the 5G number continues to grow.

So it's kind of a foregone conclusion that 5G will eclipse 4G going forward.

Got it.

And then, can you just talk about your progress with some of the international customers on 5G?

There is a big portion of China for 5G.

So maybe specific to China, how is your progress there in the market for 5G?

Sure.

Yes.

I'll take that.

This is Mark.

So progress in China is great.

And part of this has to do with some decisions that we made as a company 7 years ago in China as we started to see the changing landscape there, which is shifting from a manufacturing focus to an R&D focus.

So we've been engaging with local indigenous companies in China, multinational companies in China.

There's a lot of leadership coming out of China today with a number of companies, and we're very well positioned.

The collaborations that Mike talked about before, the example that we provided today with Qualcomm is representative of a lot of the work that we're doing around the world, and China's a heightened place for that.

And also, as we mentioned before, with the investments being made in developing local semiconductor capabilities and the foundries that feed into these industries, we're also very well prepared there as well.

So it's going quite well.

This is Ron.

Just another comment along those lines.

We've worked with Datang, and they are the ones that sit on the standards bodies in China, where that standards body, for instance, has to be -- you have to be from China to be on it.

But we're an advisory member to them, and we've been working with them for a while on 5G.

Another one is Spreadtrum.

I was there about a month ago, and we've opened up a joint innovation lab that really helps out in -- and helps the direction of 5G.

Another one -- I was just visiting with SMIC.

We have a partnership with SMIC, and we put together a memo of understanding for collaborating, which we'll move into 5G also.

So we are working at the highest levels with the market makers in China to influence the standards and to be the solution provider of choice.

Your next question comes from the line of Jess Lubert with Wells Fargo.

I'm not going to ask you about 5G.

So maybe just a couple on the Ixia deal.

And I was hoping you can maybe help us understand some of the factors leading you to believe you can capture the $40 million of cost synergies quicker than you originally expected, where those savings are likely to come from.

And given it sounds like you're seeing some early success there, to what extent do you think you have a chance to upside the original goal of $50 million in 24 months and $60 million in 3 years?

Yes, so it's a great question.

I appreciate the opportunity to provide more details.

So obviously, the acquisition's been closed for a little over a month at this point, and that's a month that we've spent really working hard to solidify and define the integration plan that we're going to be putting in place over the course of the next 9 to 12 months and to make sure that the assumptions that we had made about where we could get cost synergies from the combination of the 2 companies, that those assumptions were correct and making sure that we still had line of sight to the $60 million.

So again, 6 weeks or 7 weeks post the close of the acquisition, very confident in our ability to ultimately get to that $60 million.

And as you noted, we're pulling forward the timeline on how quickly we're going to be able to get the first $40 million.

We're not, at this point, ready to commit to upside, but we do have a direct line of sight to that first $40 million and are working on a plan to get that out of the first 12 months.

If you look at where that's coming from, it's a combination of supply chain efficiencies as well as operating expense efficiencies, primarily as we look to combine -- bring the 2 IT environments together.

So that's the -- those are the #1 things that we'll be working on here.

The costs are coming out of both -- from both sides of the equations.

We're leveraging the best of both companies as we bring them together and are very pleased at what we have found as far as opportunities thus far into our integration planning.

And then just in a similar regard, can you talk to us a little bit about how you're feeling about the revenue opportunity?

And what are you hearing from the combined sales teams, channels, customers, about your ability to kind of cross-pollinate the products from Keysight into the Ixia base and vice versa and some of the incremental opportunities that could drive over the next few years?

Yes, so it's a great question, and we're -- just as we are often running on working on identifying the cost synergy opportunities, we're similarly often running on generating revenue synergies.

As we have communicated previously, we really identified 3 areas where we expect to get revenue synergies.

One is from leveraging the breadth and the international scope of Keysight's field to provide qualified leads to the Ixia team.

There are some subsegments of the market where that actually works in the reverse direction, where Ixia's relative strengths are going to provide opportunities for Keysight; then there's an opportunity for us to accelerate the investment in the channel for -- specifically as it relates to the pursuing the visibility opportunity, the fast-growing visibility opportunity; and then finally, bringing the 2 technologies together to bring these solutions to market.

In just a minute, I'll let Bethany comment on her perspective on how that's going kind of one month in.

The one point that I did want to make is we do expect to publish our 10-Q tomorrow, and that will include some historical revenue numbers for the combined companies for both the prior 6 months -- the first 6 months of FY '17 but are pro forma compared to FY '16 as well, so you'll be able to see those numbers in our Q when it drops tomorrow.

Bethany, would you care to comment on the revenue synergy opportunity as you see it 6 weeks after the close of the transaction?

Sure, happy to.

Thanks for the question.

So I think it's going very well, both within Ixia as well as Keysight, and we've identified some great opportunities.

One, as Neil had mentioned, is that there are opportunities for Keysight's sales force to help Ixia's sales force engage in customers where we haven't been and vice versa.

On our side of the equation, there's opportunities where we have very key relationships in certain customers that we can engage to help Keysight.

And so that activity is -- we're pursuing that very heavily.

The second one is the go-to-market activity.

And basically, that's an investment on the part of Keysight into Ixia's go-to-market in our channel to essentially leverage the channel that we have and grow that.

And so we're very excited about that because we have an opportunity for double-digit continued growth on the visibility side of our product portfolio and that will really aid us in that growth opportunity.

And then on the technology areas of potential revenue synergy, there are 3 key areas that we focused on together as a combined company.

One is in the data center with high speeds.

As you know, we are the network test market leader for 400-gig, and we came out with the first 400-gig PAM-4 [QDD] test product that is on the market today, and it's very exciting for us and for our customer base.

And so we're able to combine our capabilities in the data center with Keysight for some really interesting opportunities across the board.

We also see opportunities in 5G with a combination of Ixia and Anite.

Some great end-to-end solution opportunities that we're already engaging customers, and we're even getting pull from the field on these opportunities.

And then the last one is in IoT, automotive and handheld.

We have products that are meant to test WiFi, particularly for IoT.

We're very well positioned in that space.

And we also have test products in automotive Ethernet.

And both of these areas are very strong for Keysight and Ixia, and we have identified some potential combined product solutions that literally can be sold to the market now.

As well as for future, we have small amounts of R&D that we can apply to create something even more differentiated.

So there's a lot of opportunity here.

And we're very excited about this, and we think that the combined companies, both very strong companies, have a lot to offer in the market and can really make an impact.

That concludes our question-and-answer session for today.

I would like to turn the conference back to Jason Kary for any closing comments.

Thank you, Heidi.

And on behalf of the management team, I'd like to thank everyone for joining us on the call today.

If you have any questions, please call us at Investor Relations.

Thanks again, and have a great day.

This concludes our conference call.

You may now disconnect.