是德科技 (KEYS) 2019 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Second Quarter 2019 Earnings Conference Call.

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

(Operator Instructions) Please note that this conference is being recorded today, Wednesday, May 29, 2019, at 1:30 p.m.

Pacific Time.

I would now like to hand the conference over to Jason Kary, Vice President, Treasurer, Investor Relations.

Please go ahead, Mr. Kary.

Thank you, and welcome everyone to Keysight's Second Quarter Earnings Conference Call for Fiscal Year 2019.

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

Joining us in the Q&A session will be Mark Wallace, Senior Vice President of Worldwide Sales; and Satish Dhanasekaran, President of the Communications Solutions Group.

You can find the press release and information to supplement today's discussion on our website at investor.keysight.com.

While there, please click on the link for quarterly reports under the Financial Information tab.

There, you will find an investor presentation, along with Keysight's segment results.

Following this conference call, we will post a copy of the prepared remarks to the website.

Today's comments by Ron and Neil will refer to non-GAAP financial measures.

We will also make references to core growth, which excludes the impact of currency movements and acquisitions or divestitures completed within the last 12 months.

You will find the most directly comparable GAAP financial metrics and reconciliations on our website.

We will make forward-looking statements about the financial performance of the company on today's call.

These statements are subject to risks and uncertainties and are only valid as of today.

The company assumes no obligation to update them.

Please review the company's recent SEC filings for a more complete picture of our risks and other factors.

Lastly, I would note that management is scheduled to present at upcoming investor conferences in June hosted by Baird, BAML and Stifel.

We hope to see many of you there.

And now, I will turn the call over to Ron.

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

Keysight delivered an outstanding second quarter with both record revenue and record earnings exceeding the high-end of our guidance and very strong free cash flow.

Our continued focus on our winning strategy and commitment to operational excellence under the Keysight leadership model are delivering strong results for the company.

Today, I'll focus my formal comments on 4 key headlines for the quarter.

First, Keysight delivered another record quarter and exceptional results.

Revenue was well above our guidance and grew 9% or 12% on a core basis to surpass $1 billion for the fourth consecutive quarter and to reach a new high.

We also achieved record gross margin, record operating margin and record earnings.

We grew earnings 47% to reach $1.22 per share, which was well above our guidance.

And we generated strong free cash flow of $192 million.

Second, we are complying with the recently announced United States Department of Commerce export control regulations with regard to China and Huawei.

Outside of China, we continue to see broad-based momentum across multiple end markets.

Customers continue to make R&D investments in next-generation technologies, which helped fuel growth in Q2, and we expect will drive Keysight's growth to between 7% and 8% for the fiscal year 2019.

Third, we are significantly ahead of our plan on the margin expansion and earnings objectives that we outlined last year at our Investor Day in March 2018.

We now expect that we will achieve the gross margin and EPS targets outlined for fiscal year '21 in this year, fiscal 2019.

This is 2 years ahead of plan.

We remain focused on operational excellence as defined by our Keysight Leadership Model or KLM.

This discipline is driving margin expansion and translating into strong earnings growth and cash flow as demonstrated by our results and provides model durability even as macro conditions change.

And fourth, as we announced today in our earnings release, Keysight's Board of Directors has authorized a new share repurchase program for up to $500 million of common stock.

The new repurchase program is effective immediately and replaces the previously authorized $350 million program, of which $160 million were remaining.

The expanded repurchase authorization demonstrates our confidence in Keysight's business and our continued commitment to return capital to our shareholders.

Now let's take a deeper look into our performance for the second quarter.

We achieved $1.22 per share in earnings, which was $0.23 above the high end of our guidance.

We delivered 47% earnings growth for the quarter and 60% earnings growth in the first half of the year.

We also delivered strong order growth.

Orders grew 14% in total and 16% on a core basis to exceed $1 billion.

As a reminder, our core metrics exclude the impact of currency movements and revenue from acquisitions or divestitures completed within the last 12 months.

Revenue grew 9% or 12% on a core basis to reach $1.093 billion, a new record for Keysight.

This represents our fourth consecutive quarter of delivering over $1 billion in both orders and revenue.

Our strategy to consistently invest in leading-edge technologies in areas of the market undergoing multi-year transformations, while also focusing on operational discipline, is delivering top and bottom line results.

Over the past 10 quarters, we have generated growth across multiple dimensions of the business as a result of our targeted investments.

Expanding our portfolio of software solutions to help customers accelerate their designs is a key component of our strategic vision.

During the quarter, revenue for our software solutions continued to grow double digits and faster than our overall growth rate.

Our innovations in software provide Keysight with a very strong competitive advantage, which we believe will continue to benefit the company for many years ahead.

Increased software sales and our focus on R&D solutions and operational excellence are all helping us generate higher corporate gross margin.

We have improved our gross margin by over 500 basis points in the first half of 2019, when compared to the same period just 3 years ago.

And we're ahead of schedule on our margin expansion plan for this year.

Moving to our markets.

We continue to see customers across the board invest in the R&D of next-generation technologies, which fueled our growth in Q2.

In 5G, we achieved another record quarter of orders.

The entire mobile communications ecosystem is now investing in solutions to support the early ramp of commercial 5G networks and devices.

Our first-to-market innovations and engagement with leading-edge market makers across the wireless R&D ecosystem continue to strengthen our position in this fast-growing market.

We had a great showing again at Mobile World Congress this past quarter.

Our solutions enabled over 15 industry-leading customers to demonstrate their innovations at the show, which highlights the greater role we are playing.

We continue to build on our 5G collaborations with many industry leaders.

This quarter, we continued our partnership with Qualcomm to establish the industry's first 5G New Radio connection in frequency division duplexing mode.

While we have been diligently investing and innovating with our 5G customers and partners for a number of years, the industry is still in the very early stages of realizing the transformative potential of 5G technology.

Commercialization to 5G networks around the world will usher in a new era of bandwidth and high-speed connectivity with a massive improvement in many network attributes, such as data rates, coverage and reliability.

Achieving this multifaceted improvement requires transformation of the entire communications stack end to end.

Keysight is uniquely positioned to address the entire network transformation from wireless to wired to the cloud.

Our solutions cover the entire communications workflow in both the physical and upper layers of the network.

As 5G drives investment end to end, we're also seeing customers invest in the Internet infrastructure R&D in advance of 5G.

In Q2, we captured R&D investment in next-generation electrical and optical tests for speeds of 400G and beyond, including key new design wins with several network and data center customers.

Our leadership position in 400G at the physical layer creates valuable opportunities at the protocol layers where customers' R&D investments follow over time.

The industry-leading 400 Gigabit Ethernet solutions delivered by our Ixia Solutions Group addresses these opportunities.

The automotive and energy market is another area where we continue to make great strides.

In Q2, we continued to see strong R&D investments in autonomous driving, electric and hybrid electric vehicles and connectivity, even as sales for manufacturing-oriented solutions slowed during the quarter.

Auto manufacturers and suppliers continue to invest in critical new capabilities for their future designs and our customers' engagements at Tier 1 accounts are deepening.

We also saw a similar dynamic in the semiconductor market this quarter where we saw solid revenue growth for our parametric test solutions.

This growth was supported by early strategic investment in next-generation 5-nanometer process technology despite the expected softness in this market that we have seen for the past couple of quarters and continue to expect in the near term.

Looking ahead, we believe we are well positioned to continue to build on our strengths, expand our leadership and take advantage of our opportunities we see in the market.

We have a differentiated portfolio of solutions across a diverse and broad set of end markets.

We continue to closely monitor the trade situation with China and the macro environment.

As reflected in our Q3 revenue guidance, we are not immune to these events.

However, next-generation R&D investment has remained strong, and we have deep engagements with industry-leading customers around the globe.

Our strategy to focus on bringing solutions to market that help customers accelerate innovation sets Keysight apart from the competition and is driving our success.

In summary, we delivered an outstanding second quarter.

In addition to achieving strong revenue growth, with our commitments to operational excellence, we are driving strong earnings growth and cash flow, while investing in key areas of the business.

We will continue to focus our investments to foster innovation, create value for our customers and outgrow the market.

Now I will turn it over to Neil to discuss our financial performance and outlook in more detail.

Thank you, Ron, and hello, everyone.

Before I get started, I will note that all comparisons are on a year-over-year basis, unless specifically noted otherwise.

As Ron mentioned, we delivered another strong quarter as we continue to execute on the demand we see in core areas of our business, while maintaining focus on operational excellence.

For the second quarter of 2019, we delivered non-GAAP revenue of $1.093 billion, which was well above the high end of our guidance range and grew 12% on a core basis.

This brings our revenue growth for the first half of the year to 13% or 15% core growth.

Our better-than-expected Q2 results were driven by continued strong demand, especially in 5G, where we have a leading position as well as superior execution by the entire Keysight team.

I will also highlight that in Q2, orders for services grew double digits.

Services demand was broad based, and we saw good adoption of our new support offering, such as Keysight Care.

Total Keysight orders exceeded revenue once again this quarter.

We delivered $1.121 billion in orders in Q2.

Orders were up 14% in total and 16% on a core basis.

Looking at our operational results for Q2.

We reported record gross margin of 64%.

This represents our second consecutive quarter of delivering record gross margin.

As Ron mentioned, our growing contribution of software revenue is helping increase our overall gross margin profile to a new level.

We also delivered record operating margin and earnings.

We achieved 25% operating margin and net income of $233 million.

On a per share basis, we delivered $1.22 in earnings, which was well above the high end of our guidance.

Our weighted average share count for the quarter was 191 million shares.

Our Communications Solutions Group generated total revenue of $676 million, up 8%, while delivering record gross margin of 63.4% and operating margin of 28%.

In Q2, Commercial Communications delivered double-digit order growth and revenue of $431 million, driven by increased 5G R&D demand across the wireless ecosystem and growth in data center-related next-generation 400 Gigabit Ethernet and higher digital tests.

In our Commercial Communications end market, the strong software content in our solutions is enabling our improved gross margin performance.

Aerospace defense and government generated revenue of $245 million, a core decline of 1% on a high year-over-year compare.

During the quarter, we saw steady spending in the U.S., which was offset by softness in some international markets.

However, we have a very healthy overall funnel for this end market.

EISG generated second quarter revenue of $299 million, up 6%, driven by strength in automotive, general electronics and next-generation parametric tests.

EISG reported record gross margin of 61.3% and operating margin of 26%.

ISG reported Q2 revenue of $118 million, up 32% over last year's soft compare of $90 million.

ISG sales were driven by strong application and security sales, along with large visibility renewals, which were recognized ratably over the course of the year.

ISG reported gross margin of 71.5% and 3% operating margin, which does not include the full benefit of the approximately $50 million in annualized cost synergies we generated from the transaction, of which about 70% are being realized within CSG and EISG.

Moving to the balance sheet and cash flow.

We entered our second quarter with $1.3 billion in cash and cash equivalents and reported cash flow from operations of $221 million and free cash flow of $192 million or 18% of revenue.

This brings our free cash flow for the first half of the year to $401 million or 19% of revenue and 98% of non-GAAP net income.

Under our prior share repurchase authorization, during the quarter, we acquired approximately 344,000 shares on the open market at an average price of $87.21 for a total consideration of $30 million.

As Ron mentioned, yesterday, Keysight's Board of Directors authorized a new share repurchase program for up to $500 million of common stock.

The new repurchase program is effective immediately and replaces the previously authorized $350 million program, of which $160 million was remaining.

Before moving to our outlook, I would like to make a few comments regarding the recently announced United States Department of Commerce export control regulations.

These regulations directly impact one of our larger customers in China that contributed approximately 2.5% of revenue in the second half of FY '18.

Our business with this customer and other leading 5G customers has continued to expand driven by the acceleration of 5G time lines and the strength and breadth of our 5G solutions.

As a result, this customer represented almost 5% of Keysight revenue in the first half of 2019, of which we believe roughly 2% was pulled forward due to the U.S.-China trade situation.

The new trade restrictions will create a headwind of revenue growth starting in Q3.

Despite this headwind, we expect to deliver between 7% and 8% revenue growth for the year, along with strong profitability.

Now turning to our outlook and guidance.

We expect third quarter 2019 revenue to be in the range of $1.020 billion to $1.060 billion.

We expect Q3 earnings per share to be in the range of $0.97 to $1.05 based on a weighted diluted share count of approximately 191 million shares.

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

Thank you, Neil.

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

(Operator Instructions) And your first question comes from the line of Vijay Bhagavath from Deutsche Bank.

So please double-click on your China exposure, Ron and Neil, please chime in.

I would like to better understand the dynamics playing inside of China and then ex China, I want to get your sense on your 5G business, in particular, any slowdown you anticipate outside of China potentially because of the Huawei kind of the whiplash effect.

Thank you, Vijay.

I'll make a general comment, then I'll pass it over to Neil to talk about the China implications and then I'll let Satish say a couple of things about our overall very strong 5G business.

So with regards to China and Huawei in particular, we are complying with all U.S. regulations and monitoring and assessing the situation as it evolves.

There are certain circumstances during this next 90 days or this 90-day period where we can ship some products to Huawei, but we obviously have other backlog and other business that we typically do get for them that we will not be able to ship.

Outside of this regulation, our business is firing on all cylinders, and we continue to grow and that's why we have guided $1.01 for Q4 in the middle of our range -- for Q3, which is in the middle of our range, despite taking into account all of these effects.

Yes.

Vijay, if you look specifically at the Huawei impact for Q3, we've reduced our revenue guide for next quarter by about $25 million as a result of the escalating trade situation in China.

The impact in the fourth quarter is larger just based on the funnel of opportunities that we had, which was more heavily weighted towards Q4 versus Q3 and in the second half of this year.

I think to just to echo Ron's point, we'll have to have a bit of a reset for this customer situation that we're going to lose, but the underlying business continues to grow very, very strongly.

We're very well positioned in a number of end markets that have -- that are just at the front end of the ramp in terms of automotive and 5G with a strong funnel of opportunities in aerospace defense that we talked about, and so we continue to be very optimistic about how Keysight is positioned as we look forward.

Vijay, at the onset, I want to start by saying on a global basis, despite the recent events, we continue to see momentum on the 5G trajectory both for our solutions and the entire ecosystem that's scaling.

In the most recent quarter, all our regions -- all the 4 regions showed strong year-over-year growth.

We've added 100 new customers in the first half into our 5G platform relative to the previous half.

And we continue to see some notable highlights in the most recent quarter, which illustrates my point.

First, we saw component supply chain enter into 5G and based on the strength of our modular platform.

Second, the NEMs, who have been declaring public contracts, have actually been investing in ramping up capacity for base stations, which is a positive.

And third, as 5G scales and deployment scenarios are being played out, the complexity as we have talked about has been high, and we've recorded design wins for our deployment tools.

Again, very early stages, but hopefully, paints the runway that we have moving forward.

I'll just add one other comment.

As Satish had mentioned, all of our regions grew triple digits in 5G and overall, we were very strongly into triple digits.

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

A question for Satish on the same topic.

As you kind of look out to March next year and sort of the finalization of the time line for the 5G standards, what impact do you think the Huawei situation might have?

And if that is delayed at all, how much of an impact do you think that has on sort of your business and sort of the ecosystem?

Yes.

There's a lot of possible scenarios that can play out, but I would say, if you look at the top drivers we look at, it's the number of operators that are actually committing and are deploying 5G.

Currently that stands at 20 and is increasing.

If you look at the number of network equipment contracts that people have declared publicly, that's been increasing throughout the year.

You look at the number 5G devices that are being put out, it's about 30.

So those are things that we look at to say, is the industry dynamic strong and it continues to be strong and healthy.

If you look at the standards, I think you point out that the 5G standards are maturing, and that's good for Release 15 of the spec.

We're actually leading in the -- from a global conformance validation perspective in enabling the industry to roll out the technology with interoperability as its core theme.

So -- and with standards starting to work on Release 16, the innovation drivers especially in R&D continue to be strong and robust.

And we see some reports that suggest that as share shifts occur, different players will continue to ramp investments, and I think, given the strength of our position over the last 3 years in 5G, we're well positioned to capitalize under various scenarios.

I'll just add 2 more comments with regards to 5G.

First, I will say that even if you were to take Huawei out of our orders, 5G still grew 198% in the quarter.

The second point that I'll add is 5G relative to legacy cellular technologies, our 5G orders have surpassed all of our legacy cellular technologies for the second quarter in a row.

So we have a very high growth component from 5G that is now larger on a dollar basis, which will carry a higher weighted average impact to our overall average growth rate.

That's very helpful.

I appreciate the color.

Maybe a question for Neil, just on the incrementals in the second quarter, pretty remarkable especially in CSG, I think, incrementals over 100%.

You sort of speak to where all that margin's coming from and perhaps the impact of Neil's greater software mix on the gross margin line?

Yes.

Brandon, thanks for the question.

I think there's a number of things.

Obviously, at Keysight, we are consistently focused on operational excellence and driving improved profitability across the entire platform.

I think in Q2, we did see a very favorable mix in our revenue during the quarter both from software, which grew faster than the overall rate of growth of the total business as well as some very favorable mix in some of our solutions platforms that were added after gross margins.

So we put up 2 consecutive quarters now of record gross margins with Q2 being close to 200 basis point improvement over the prior record.

I think as we look forward, we're very encouraged by the gross margin profile that we see.

It's not quite as strong as what we saw here in the second quarter, but we're very encouraged by the gross margin profile that we have, which is driven by the solutions approach that we're taking to market.

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

You've been very clear and transparent, which is appreciated, on the Huawei challenges given the trade war tensions and tariffs and such.

However, what I'd like to do is increase the scope a little bit.

If my memory is correct, I believe China is closer to like an 18% of your total sales.

Do these new tariffs impact that or the customer behavior or any other potential customers indirectly?

Because I know that the supply chain is very complex, but again, you spoke about Huawei, and I think all the questions are answered there.

But anything about broader China and these tariffs we should be aware of that you're working on or keep an eye on, on your dashboard?

Yes.

This is Ron.

China is about 17% to 18% of our total business.

We have looked at the indirect China impact on what is going on talking with our sales organization on a daily basis, all of that has been included in the guide.

Things can change in the future, but we're doing things such as redeploying our sales force from an account that can't sell on into other areas.

On top of that, Mark Wallace is also expanding the sales force, and I'll let him give you a little bit of an update on that which will drive our growth.

Sure.

Thanks, Ron.

Jim, so yes, that's very true.

In all of our regions, we're expanding our sales force on course to doubling the number of front-line sellers so we're well on course to doing that.

You heard me talk about that at the Investor Day last year.

In China, the same thing is happening.

We're continuing to deploy resources and we are very resilient, especially in China to be able to redeploy resources dynamically as opportunities change.

So we're doing that as we speak.

I do want to point out though in Q2, with the prior headwinds that we had for semiconductors and some of the RPL companies, we still had record revenue in Q2.

So there is still a lot of great business in growth.

The broader business in China is holding up reasonably well.

As we mentioned, we have a broad portfolio of solutions and a lot of diverse end markets, including 5G, including automotive, general electronics.

So the combination of our ability to cover these customers, redeploy dynamically and bring the total solution set that we've been doing to market is a formula for success.

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

Congrats on a very strong quarter.

I was hoping you guys could talk a little bit about the competitive landscape in 5G specifically.

Very much appreciate you guys have a great lead over your competition, but at the margin, it does feel like your 2 competitors, in particular, are trying to play catch-up here.

If you can point to some of the differentiating factors that separate you guys from the rest of the pack, that would be helpful.

Then I have a follow-up.

Yes.

This is Ron, and I will turn it over to Satish in 1 minute.

Obviously, if you look at the growth rates of the other -- of the competitors, you can see how they're doing.

We don't comment specifically on our competitors, but we will tell you a little bit about our strengths, and I'll let Satish fill in some of the holes.

Thanks, Ron.

I'd say that the first reason why customers buy from us is the experience that we have gained over the last 3 years working on 5G.

This has been an imperative since the company was formed that Ron has laid out, and we continue to execute, but execute not just on our internal programs, but with our customers.

The second reason we feel good about our runway is because of the -- our expansion into the software layers of test, which has gone on well.

We've had 31 collaborations just this year that we've announced with industry partners, which continues to build on some of the collaborations we've had, but also new customers who are entering our platform.

And then third, it's all about the end-to-end equation.

You hear about this as terms and jargons, but for us it means we cover the whole ecosystem with life cycle solutions.

The only reason we can do that is we have capabilities, all the way from Anite to Ixia now that are providing us considerable insights and abilities to be able to execute to key milestones of our customers.

So that's in short our value proposition here.

Great.

And then as a follow-up, I had a question on margins, and I guess, this would be for Neil.

Really encouraging to hear that you guys are pulling in your targets by 2 years.

If you look back, what are some of the things that drove the upside to margins?

Was it primarily better revenue and perhaps stronger service mix and maybe high-value add products from 5G?

Is there anything that I'm missing there?

And then more importantly, going forward, how are you guys thinking about gross purse margins as well as operating margin?

Is it more about revenue growth going forward or is there opportunity to expand margins further?

Yes.

I think you hit most of the items.

Obviously, we continue to see our software business outpace the overall growth of Keysight in total.

And over the past couple of years, that growth has been significantly above our long-term model.

And as we've talked about, we have a great ability to drive leverage -- profit leverage from growth.

I think if I was to step back big picture and say what's driving our improved gross margins, it's the fact that we have changed our approach to go-to-market to one that's focused on end industries, on industry segments and bringing complete high-value solutions into the marketplace.

And those differentiated solutions are enabling us to increase the gross margins.

The other thing that we've talked about repeatedly is our kind of decade-long at this point or more than decade-long effort to migrate more of our solution selling into our customers' R&D labs and really target the areas of manufacturing that are higher-margin opportunities.

And so all of those things in concert are now starting to hit and they layer on top of one another and are starting to have a very measurable impact for the company.

I'll just add a little bit more.

We have really focused on operational excellence, and we have a program that's in place across all 12,900 employees here at Keysight to improve operational excellence, which is part of our Keysight leadership model.

But Neil has really hit the nail on the head.

It's our differentiation, when our customers go ahead and they look at total solutions, which is not only the world's best hardware, but the best application and measurement IP in software as well as our services capability across a broad range of products, we bring solutions that cannot be brought to bear by many of our competitors.

And this is giving us the ability to not only do a great job of selling our products, but to also capture this differentiated value.

And then maybe on the go-forward [basis]?

Just what I said, over the kind of intermediate term, as we look into the second half of this year, our gross margin strength and our funnel and then our backlog is strong, but it's not quite at the level of what we're seeing here in the second quarter.

But we continue to see very strong gross margin as we talked about.

We believe we've achieved and can sustain the FY '21 gross margin target that we outlined at Investor Day in March last year.

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

Ron, can I just circle back for a minute or 2 around 5G in China and in particular, Huawei?

With their significant kind of patent to the IP around 5G and the different dynamics there, is there a sense that -- could Huawei look to other vendors, non-U.

S. vendors on the test side if this stays -- if this kind of restrictive list kind of stays in place?

And how does that restricted list, I mean this is different from the tariff resolution, but how does that issue get resolved from your perspective?

I mean maybe those are the 2 questions around Huawei and 5G.

Yes.

The first thing that I'll say is with regards to Huawei, if they cannot sell for instance into the U.S. and into some other countries, that business will go somewhere else.

And again, they'll capture some of the business, but other business will go to players such as Samsung or Nokia or Ericsson, and we're not here to predict which one will win, but all I can tell you is we have very strong positions in all of them.

So some of that business can be displaced into some of their competitors.

We do have a competitor in Japan and a competitor in Germany, Anritsu and Rohde & Schwarz, but we have been significantly ahead of them, and we believe we still will be very well positioned as we go forward in the future.

Okay.

And then just maybe a follow-up question on Ixia, maybe for Neil.

Can you just -- great progress all over on margins here in the other segments.

But could you just kind of maybe lay out some sort of a road map for Ixia's profitability?

I mean is that due mainly to investment or is our single-digit operating profit at Ixia, does it move to double digit over the course of 18 months or 12 months or how do you see that unfolding here?

Yes.

We definitely see an intermediate to longer-term opportunity.

We have a pretty dramatic improvement in Ixia's profitability.

I think we're continuing to wait for the 400-gig ramp to hit the Ixia portion of the business.

We're seeing that pretty strongly right now in Satish's business on the physical layer side, but we know that the protocol layer sides are going to lag.

And so we'll look to the back half of this calendar year or early next calendar year for those to hit.

Ultimately, with the business that has 70-plus percent gross margins, the best way to fix the bottom line is to get the business growing, again.

I do think it's worth noting from a profitability standpoint just reiterating the points that I made on -- in the prepared remarks, we have generated $50 million of cost synergies in this business or as a result of this transaction, but 70% of those synergy value is actually being realized within our Communication Solutions business and Electronics Industrial Solutions business.

And you can see that in their increased levels of profitability.

And so you couple that with the variable pay impact of having -- that comes with our variable pay programs that are based on organic growth and operating margin that are paying out at historically high levels, and the Ixia picture is far better than maybe it would appear if you just look at our segment results.

I would also add on top of that we are investing in R&D at a higher percentage of revenue than has been done in a long period of time, if not ever.

And you couple that with the light cycle investment that we expect to see in some of their solutions, and we feel like we have some real movement that will happen there.

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

I was wondering if maybe we can shift gears just a little bit and talk about the ADG group and that slowdown there this past quarter.

It sounded like the U.S. remained relatively stable for you, but you did see drop-offs elsewhere.

Just curious how to think about some of the puts and takes there going forward as we look to the second half of this calendar year?

Yes.

Thanks, John.

I will just say this, we have a very, very full funnel right now.

Obviously, all of it has not been released, but I'm going to let Mark Wallace tell you a little bit more about the details.

Yes.

Okay.

John, thanks for the question.

Q2 of '19 was first of all a tough compare.

It's the second largest Q2 for orders since we formed as Keysight.

So we had a decent quarter, and as you pointed out, the growth that we realized from the U.S. was coming both from the direct government and some of the contractors.

The other thing that is not as visible all the time is that our services business as part of solving customers' problems within aerospace defense continues to grow and that's true around the world and, in particular, we're hoping to optimize their equipment uptime and utilization.

And I see a lot of runway here to complement our high-end equipment and solutions business.

The other thing is -- there is pent-up demand in the U.S. in particular because there are some continuing delays in funding and appropriation.

While we saw some of that release in Q2, we'll be monitoring this very closely obviously as we get closer to the end of the fiscal year for the U.S. government.

And 5G is everywhere.

We're seeing 5G opportunities in aerospace defense as well, we're seeing 5G opportunities in automotive.

So our broader solution set as well as our footprint is applicable here in aerospace as well.

So the longer-term outlook remains unchanged.

We will see continued investment because of increased R&D spending for some of the advanced technologies that we have great solutions for.

And then maybe, Satish, just a quick question for you on the broader outlook for 5G.

I'm wondering if you can comment at all on sort of sub-6 versus millimeter wave.

Where you're seeing some of that activity and if anything that's happened recently certainly impacts that or how you look at those 2 sort of competing versions of 5G developing going forward?

Yes.

I think a good question.

To start off, I'd say clearly the ecosystem is ramping and it's ramping sort of based on regional needs, some parts of the world starting to deploy sub-6 gig first and some have started with millimeter wave and the densification play with 5G.

The strength of our platform is that we've designed it to be modular from grounds up.

You start off with sub-6 gigahertz, add millimeter wave or you start off with an SA, which is the stand-alone version, and get to NSA and vice versa.

Because of this sort of ability to move seamlessly between different implementations, we're able to service a global ecosystem, which is why our 5G orders for this quarter ended on a record note and we continue to see that momentum build out.

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

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

Thanks, Christine, and we appreciate everyone joining us on the call today.

To close this out, I'll turn it back to Ron for some final comments.

Thank you, everyone, for joining us.

We really appreciate you staying with us, and we really appreciated the chance to share these Q2 results with you.

Obviously, record Q2 orders for the highest Q2 in history, record revenue, record gross margin, record operating margin and record non-GAAP EPS makes us very happy.

The other thing that was very impressive was our strong EPS growth at 47% in Q2 and 60% in the half and our $192 million of free cash flow, which was an 82% conversion.

Also we're very glad that we were able to deliver to you a revenue and EPS significantly above the range.

But what makes us even more excited is as we look forward, the margin expansion programs that we've been working on for years have paid off and they've paid off early, and we believe that will generate lots of cash for us as we look to the future and accordingly, we have put in place a $500 million share buyback program, thanks to our Board of Directors.

But we're very bullish on the future and on our growth initiatives going forward.

Of course, you'll have a bump in the road here and there with some competitors, but we are growing on so many different vectors.

We look forward to reporting to you next quarter.

Thank you very much, and have a great day.

This concludes our conference call.

You may now disconnect.