是德科技 (KEYS) 2021 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Keysight Technology Fiscal Second Quarter 2021 Earnings Conference Call. My name is Holly, and I'll be your lead operator today. (Operator Instructions) Please note today's call is being recorded today, Wednesday, August 18, 2021 at 1:30 p.m. Pacific Time.

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

Thank you, and welcome, everyone, to Keysight's Third Quarter Earnings Conference Call for Fiscal Year 2021. Joining me are Ron Nersesian, Keysight's Chairman, President and CEO; and Neil Dougherty, our CFO. Joining us in the Q&A session will be Satish Dhanasekaran, Chief Operating Officer; and Mark Wallace, Senior Vice President of Global Sales.

The press release and information to supplement today's discussion are on our website at investor.keysight.com. Click on the link for quarterly reports under the Financial Information tab, where you will find an investor presentation along with Keysight's segment results. Following this call, we will also post a copy of the prepared remarks.

Today's comments will refer to non-GAAP financial measures. We will also make references to core growth, which excludes the impact of currency 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. All comparisons are on a year-over-year basis, unless otherwise noted.

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 our recent SEC filings for a more complete picture of risks and other factors.

Lastly, I would highlight that management is scheduled to participate in upcoming virtual investor conferences hosted by Jefferies, Deutsche Bank and Citi.

And now I will turn the call over to Ron.

Thank you, Jason, and thank you, everyone, for joining us. Keysight delivered another quarter of excellent results. Solid industry dynamics are accelerating demand for our differentiated solutions, and we continue to capitalize on broad-based technology investment across a diverse set of growing markets.

Today, I'll focus my comments on 3 key headlines. First, we delivered record Q3 orders, all-time record revenue and our highest quarterly operating margin of the year. The durability of our business model was on full display as we continue to effectively navigate supply chain challenges.

Second, Keysight's first-to-market software-centric solution strategy continues to yield consistently strong results. Since our launch in 2015 through our expected 2021 finish, we will have delivered 9% compound annual revenue growth and 16% annualized earnings growth, both well above our long-term commitments despite significant headwinds of trade restrictions and a global pandemic. Our investments are well aligned with the highest impact market opportunities as we continue to enable our customer success and deliver value to our shareholders.

Third, given our outstanding performance year-to-date, we expect to achieve 2021 year-over-year revenue growth of 16% and EPS of $6.03, which represents 24% earnings growth at the midpoint of our guidance. We have strong momentum entering 2022, and our long-term revenue and earnings growth targets remain intact and we expect to drive incremental margin expansion going forward.

Now let's take a deeper look at our third quarter performance. Record Q3 orders of $1.3 billion grew 23%. All-time record revenue also grew 23% to $1.2 billion. We delivered gross margin of 65%, operating margin of 27% and earnings of $1.54, which was well above the high end of our guidance and represents 29% year-over-year earnings growth.

Keysight continues to deliver outstanding growth despite year-over-year headwinds due to trade restrictions and ongoing supply chain disruption. Our growth rates are not only just a result of soft year-over-year comparisons, but also reflect sustained multiyear above-market growth. For example, Q3 orders are up 18% and revenue was up 15% versus the same quarter in 2019 prior to the global pandemic. The strength and durability of our business model are delivering as expected. We see accelerated demand from our differentiated solutions from both existing and new customers. Our customer engagement throughout the pandemic has been strong with approximately 1,900 new customers added in 2020, which we would expect to exceed in 2021.

Looking at our business segments, for the third quarter in a row, we reported double-digit year-over-year order and revenue growth across both segments and all regions, demonstrating the breadth and differentiated portfolio across a diverse set of end markets. Our Electronic Industrial Solutions Group achieved strong double-digit order and revenue growth across all regions as well as its fourth consecutive quarter of record revenue. Continued investment in chipsets for 5G data center, cloud and AI applications drove demand for our differentiated semiconductor solutions, resulting in another quarter of record orders and revenue.

Investment also remains high in advanced technology nodes and capacity expansion for mature processes to address surge in global semiconductor demands. Our general electronics business achieved record Q3 orders and revenue. Four consecutive quarters of double-digit order and revenue growth demonstrate Keysight's breadth of contributions across multiple industries. Strength in the quarter was driven by investments in customers' broad-based digital transformation, industrial IoT, digital health, Industry 4.0 and advanced academic research.

In automotive, record Q3 orders and all-time record revenue were driven by the ongoing macroeconomic recovery, acceleration in EV and AV technology investment and manufacturing expansion to meet pent-up demand.

As the trend towards autonomous vehicles gains momentum, Keysight remains focused on enabling next-generation technologies across the automotive R&D workflow. We recently announced a new cellular vehicle to everything, or CV2X, autonomous drive emulation solution, which provides a real-world environment emulator for in-lab testing to simulate realistic roadway scenarios. We continue to see steady demand for our EV and AV solutions, including automotive Ethernet compliance and cybersecurity test.

Our Communications Solutions Group achieved record third quarter orders and revenue and delivered double-digit order and revenue growth, despite trade restrictions that impacted one of our larger customers in China.

Aerospace, defense and government delivered record Q3 orders and revenue. Revenue grew double digits across all major regions. While benefiting from a soft prior year comparison, growth was again driven by space, satellite, electromagnetic spectrum operations, 5G and early 6G research applications. U.S. government and prime contractor investment was strong while internationally, Europe rebounded from a year ago, coupled with solid growth in Asia.

Our Application Solutions strategy drove a significant win with a leading research institute in this quarter. Keysight's leading-edge integrated wireless and wireline test bed is enabling their next-generation terabit and 6G research. Our aerospace, defense and government customers will also benefit from our differentiated services offering to enable their mission-critical program needs. In Q3, we entered into multiple U.S. prime contractor engagements for calibration and uptime services.

Commercial communications achieved third quarter record orders and revenue. Adjusted for the impact of China trade restrictions, Commercial communications orders and revenue both grew double digits. Ongoing strength was driven by global 5G deployments and the rollout of new 5G chipsets and devices, O-RAN adoption, 400 gig and 800 gig Ethernet for data centers and increased spending by service providers. Our collaboration with key 5G innovators remain strong as we continue to lead with new industry firsts.

In partnership with Qualcomm, we were the first to achieve 10 gigabit per second 5G data connections. Keysight was also selected by Vodafone, along with other industry leaders such as Samsung, NEC and Dell to deliver end-to-end cloud solutions for the deployment of Europe's first commercial O-RAN network.

Sanjole, acquired earlier this year, had a strong quarter driven by expanding adoption of our WaveJudge wireless test system, which further enhances Keysight's 5G solutions for deployments. Keysight continues to enable next-generation wireline standards, such as 800 gigabit Ethernet. Our newly announced 800 gigabit Ethernet solutions saw strong demand within the quarter. In recent partnership with Cisco and Amphenol, we demonstrated high data rate multi-vendor interoperability, a key enabler of next-generation networks. The combination of our network application solutions from the Ixia acquisition and our leading physical layer bit array testers and oscilloscopes is driving new levels of customer insight and value.

Our software and services solutions remain an important growth vector for Keysight. Higher-value services are driving differentiation while strengthening our competitive position. At greater than 30% of total revenue with ARR exceeding $1 billion, our growing mix of software and services is increasing the durability of our business model while reducing overall cyclicality. They are both contributing to Keysight's margin expansion with operating margins at or above the company average.

Keysight's focus on operational excellence continues to drive our consistent execution, and our employees are critical to our success. Employee growth is a key component of the Keysight leadership model, and we view our high-performance culture as a competitive advantage. As such, we are honored to have our team in Malaysia recognized as the overall winner of the Employee Experience Awards by Human Resources Online. This award is in recognition of the innovative programs deployed in the Malaysia HR team to proactively engage employees and create positive experiences despite unprecedented pandemic-related challenges.

Our employees in Malaysia have done an outstanding job under difficult circumstances since COVID restrictions were imposed and our production operations were impacted. To mitigate the risk of COVID-19 to employees, customers and suppliers, Keysight implemented a vaccine program for both Keysight employees and their suppliers. Over 95% of our employees at the Malaysian facility are now vaccinated. In addition, vaccination rates at our large U.S. sites are above their local community averages.

In summary, our momentum continues, and our strategy is generating strong results. We have a track record of consistent execution and delivering on our commitments. I am confident in our ability to capitalize on many growth opportunities ahead of us as we finish the fiscal year and look forward to 2022.

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

Thank you, Ron, and hello, everyone. As Ron mentioned, Keysight delivered another outstanding quarter as broad-based technology investment accelerated demand for our differentiated solutions, resulting in better-than-expected results in the quarter.

Third quarter revenue of $1.246 billion was above the high end of our guidance and grew 23% or 21% on a core basis. We achieved third quarter orders of $1.310 billion, up 23% or 20% on a core basis. Excluding the impact of China trade restrictions, orders grew 29%.

Turning to our operational results. We reported Q3 gross margin of 65%, which increased 60 basis points year-over-year. Operating expenses of $472 million were well managed despite higher variable compensation. Operating margin was 27%, up over 100 basis points.

We achieved net income of $286 million and delivered $1.54 in earnings per share, which was above the high end of our guidance. Our weighted average share count for the quarter was 186 million shares.

Moving to the performance of our segments. Our Communications Solutions Group, or CSG, achieved third quarter revenue of $875 million, up 15%. CSG delivered gross margin of 66%, which increased 50 basis points year-over-year. Operating margin was 26%.

Commercial communications revenue of $595 million increased 6%, driven by continued investments across the 5G life cycle and our leadership in emerging applications. As Ron mentioned, adjusting for the transient impact of unfavorable trade restrictions, commercial communications revenue grew double digits.

Aerospace, defense and government revenue of $280 million grew 39% and recorded double-digit growth across all major regions, led by U.S. and Europe.

The Electronic Industrial Solutions Group, or EISG, generated another record revenue quarter of $371 million, up 48% or 44% on a core basis. Order and revenue strength was notable across all markets and regions as semiconductor, general electronics and automotive solutions orders and revenue all grew strong double digits. EISG reported gross margin of 64% and record operating margin of 31%.

Moving to the balance sheet and cash flow. We ended our third quarter with over $2 billion in cash and cash equivalents and reported cash flow from operations of $257 million and free cash flow of $217 million or 17% of revenue. Our capital allocation priorities are unchanged and remain focused on investments in organic growth, value-creating acquisitions and share repurchase.

Under our share repurchase authorization, during the quarter, we acquired approximately 570,000 shares on the open market at an average price of $140 for a total consideration of $80 million.

Now turning to our outlook and guidance. We expect fourth quarter 2021 revenue to be in the range of $1.250 billion to $1.270 billion, which represents 3% revenue growth at the midpoint. Full year revenue at the midpoint of our guidance is $4.9 billion, representing 16% revenue growth. We expect Q4 earnings per share to be in the range of $1.59 to $1.65 based on a weighted diluted share count of approximately 186 million shares. Full year earnings at the midpoint of our guidance is $6.03, representing 24% EPS growth.

In closing, our expected 2021 revenue and earnings per share represent 7% and 13% compounded annual growth over the last 2 years since 2019. Both are not only above our long-term expectations, but accomplished in the face of significant COVID-related disruption last year and the substantial negative effect of China trade restrictions.

Our consistent execution demonstrates the resilience of our business and our ability to drive sustainable and profitable growth. Beyond 2021, our long-term revenue and earnings growth targets as well as our financial model remain intact as we see continued opportunity for incremental margin expansion.

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

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

(Operator Instructions) And our first question will come from the line of Jim Suva with Citi Group.

We'll go to the next caller. Our next question will come from the line of Mehdi Hosseini with Susquehanna.

Yes. Two follow-up questions. Regarding the communications group, could it be possible that some of the high-end equipment that you sell that is used for high frequency and traditionally categories under communication -- under commercial communications is now categorized in mil/aero or vice versa, like it's early in the adoption, maybe more of a millimeter wave application is currently categorized in mil/aero? And then when it's commercialized, it would be reclassified under commercial communication? And I have a follow-up.

Yes, Mehdi, this is Satish. I'll take this. Clearly, the focus for us is to maintaining a lot of leverage across our portfolio between CSG, both commercial and aerospace and defense, and in our industrial business. So across the portfolio, we sell a common set of tools to all engineers.

And you're right in pointing out that the millimeter wave opportunity is pretty broad. Now it will take quite a bit of time to play out in the end markets driven by spectrum and different interests across the globe. But it is broad, such as millimeter wave is clearly being used in space and satellite communication. It's being used in aerospace -- in automotive, for sure. And now with commercialization of this technology, it finds its application in 5G.

And we actually classify orders based on customers who buy them, and we're able to maintain a lot of operating leverage across our businesses that way.

Got it. And then I wanted to follow up for Neil. When are we going to get an update on the longer-term target operating margin? I know you have been focusing on increasing the ratable mix of business, the software mix. But you have been operating above the long-term target. And I just -- we're in a phase where, like, for how long can you operate above it? Any kind of metric, any update will be great here.

Yes. So I'll just make one final comment to tack on Satish' answer. As a result of our classification of sales by customer, we actually have 5G orders and revenue not only within aerospace, defense and commercial comms, but also within EISG as well because of the way that, that is done.

Under your question about kind of long-term operating model. First, we're very pleased with the results. If you look at our 3 quarters to date here in FY '21 plus our guide for Q4, we expect to finish this year with operating margin basically at the long-term target that we outlined at our March 2019 Analyst Day, where we said 26% to 27%. We're going to be at that 27% level here in FY '21. So we're pleased that we've achieved that objective 2 years ahead of where we expected to achieve it. So we've been making progress faster than expected.

And then as we said in our prepared comments today, we don't believe that we're done. We believe that we have continued room for margin expansion. And while I don't have an updated guide for you here today or an updated long-term model, I will tell you that we do have multiple levers that we're working across the business. You noted a couple of them, continuing to grow our software and services businesses at a rate that's faster than the overall company average, and therefore, growing our ARR at rates that are faster. A broad set of initiatives focused on gross margin improvement, where we've seen our gross margin improvement over the last several years go from the upper 50s into the mid-60% range, and then continuing to leverage our G&A infrastructure.

And so we believe we continue to have a lot of levers. We -- and we remain confident in our ability to continue to drive margin improvement going forward.

And our next question will come from the line of Jim Suva with Citigroup.

Great. When I think about longer term, specifically your end markets and I look at them, I kind of take a look at automotive, where it looks like you've kind of been underpenetrated or are these a smaller portion of your sales. As you look ahead, is that something that you think could materially be pretty big for the company in the years ahead? Or is there something unique about it?

I mean I look at every car that's being sold out there or the newer ones coming out. They just have a lot more electronics and things that need to be calibrated and tested. Or is there something unique about that industry that would prevent you from going into it? Or maybe it's already big for you now, how much is it? Is the profitability the same? It seems like the design times would actually be more favorable because you design a car for multiple years compared to like a consumer electronics. So maybe if you can just give us some insights on the automotive strategic view that you may have.

Sure. This is Ron. If you take a look at our overall automotive business, it is really transforming in a very large way. As you know, the automobile is really turning into a computer with big batteries and a lot of wireless sensors that communicate to many, many different devices.

And that really plays right into our strength. In the old world, the electromechanical car with a combustion engine was relatively low tech with regards to electronics. Sure, there are transducers and things that are put on suspension systems to look at shocks and engine performance, more and more. But more and more microprocessors are in cars, and the whole car itself is really built around electronics that we test, whether it's computers or the wireless sensors for either radar or for 5G, et cetera. So we see this as a very big long-term trend for us.

As far as production, it depends. Things that are more complex, we're going to have a role in. Things that get reduced to simple test, we won't be playing in that area as it's a very price-competitive market that doesn't really need as much value from us. But in R&D, where we focus -- that is the sweet spot for us. So R&D-focused, AV, EV technology is really, really a great opportunity for us going forward.

And our next question is going to come from the line of Matt Niknam with Deutsche Bank.

I have one on supply chain and one follow-up. Just on the supply chain, you've obviously managed to navigate through some of the challenges here you're seeing. Can you just comment on whether you saw any incremental headwinds or even tailwinds or improvement relative to last quarter and then thoughts on any impact you've embedded into next quarter's guide?

And then my follow-up, you talked about adding 1,900 new customers last year and expecting to exceed that this year. Just any color you can provide in terms of SKU or mix in terms of where these new customers are coming from?

Sure. This is Ron. I'll start off on the supply chain answer and then turn it over to Neil as we go forward. And then Mark Wallace, our Head of Sales, will talk about the excellent progress on our new customers.

First, with regard to the supply chain, we've commented on this before. The more complex semiconductors that are in our products, we make right in-house. So we have a boutique fab that has to produce products that literally have, in many cases, 10x the performance of commercial products because we're the measurement device and we have to be more accurate to be able to measure the performance on the commercial devices.

That gives us more control of our supply chain, although we do obviously buy parts and some common components from other suppliers. But I think we have an exceptional management team and order fulfillment. We have the largest order fulfillment organization in the test and measurement industry. And I think they've done an excellent job working with our suppliers.

There is no doubt that we continue to beat our expectations quarter after quarter after quarter. But obviously, if there were more components, we'd be even able to take our revenue up a little bit more quickly. Now I'll turn it over to Neil, who will add to more commentary.

Yes. Just we're not immune to the supply chain situation. I think that's where I would start. But as Ron said, the kind of the vertical integration of our supply chain and the fact that we control the production of our most highly specialized parts really helps to mute the impact.

And so while the impact is not 0 within the quarter and it's not 0 within Q4, where we just guided, the impact is relatively small. And so I don't think it's a terribly huge concern. I think we're doing a good job managing the expectations of our customers in getting product into the hands of customers on a time line that they find to be acceptable. I can't point to any examples at this point where we have had orders canceled because of an inability of us to manage our supply chain risk and get product into the hands of our customers. So yes, I'll leave it at that.

And with regard to new customers, before I turn it over to Mark, that's an effort of doing many different things. First, we have added many folks to our feet on the street program that Mark will talk about or direct field engineers or salespeople that could expand our presence. We've worked in indirect channels and expanding our efforts there as well as increasing our marketing efforts to make sure that people understand their value. And all of those things feed on top of each other.

That's right. Thanks Ron. And Matt, I'll just build on that. As you've heard, our results were very broad-based across all segments and all regions. And we put a lot of attention, as you hear from these calls, on innovating with the industry leaders, our largest customers. Our top 20 were up strong, high double digit. But we added 600 -- more than 600 new customers during Q3. And as Ron mentioned in his prepared statements, we're on track to exceeding 1,900, which we added last year.

And this is by design. We have a focus on reaching new customers through a combination of marketing, our direct channel, which at the end of this year will be more than twice as big as it was just a few years ago; and through our indirect channel, which is a combination of distributors and our e-commerce platform, where the majority of customers who access Keysight electronically online are new customers.

So I think you could think of it's broad-based across all the segments that we are focused on and delivering solutions to today. And it gives us this broader footprint and this higher diversity of customer base that adds to our strength in addition to the top line growth that delivers quarter after quarter.

Our next question will come from the line of Chris Snyder with UBS.

My question is on the guide, which puts, I think, FQ4 revenues at the midpoint about 4% below FQ3 orders. I mean looking back the last few years, FQ4 revenues had outpaced the Q3 orders. So does the guidance reflect expectations that supply chain headwinds will persist? Or are we seeing longer customer lead times? Or just a longer-duration backlog as the company continues to push into software and return revenues?

Yes. I think it's a mix of several of those factors. I certainly don't feel like at this point that we can say the supply chain concerns are behind us. We're continuing to very actively manage supply chain, and we do expect there continue to be some limitations on our ability to ship as a result of those supply chain constraints going forward. I think you highlighted some of the efforts that are going on in our services and software business that are resulting in increases in our deferred revenue accounts and the ratable recognition of some revenues.

And then I think in some markets, most notably the semi market, we have seen customers look to place orders earlier in the system or for delivery later out just as they're looking to secure supply and communicate their own needs. But we take comfort from the fact that we see the amount of fab construction that is underway and believe that those orders, particularly given the relationship that Keysight has with that relatively limited customer set are very strong.

Appreciate all that. And I just wanted to follow up on the previous comments around new customers. 1,900 new customers is a lot for a company who has kind of the market share and the history that Keysight has. So I guess just to kind of simplify it, is all -- is the strong rate of customer additions driven by just the fact that the total addressable market here is expanding as we're seeing that 5G ecosystem bring new verticals into it? Or is the company taking wallet share from just existing customers that maybe haven't done -- or existing people in the supply chain that have not done business with Keysight previously?

Yes. Chris, this is Mark. I'll add some more color on that. You have to first start with the baseline that we do business with more than 30,000 customers each and every year, so we have -- in more than 100 countries. So our presence is broad and wide. You did hit on one of the key elements, which is the expansion of various ecosystems. O-RAN is a great example that is accelerating, bringing new customers into the 5G ecosystem. And then the success we're achieving in really all the ecosystems is expanding our footprint through that leverage.

The other part, again, that Ron mentioned is the combination of marketing and increased selling capacity is enabling us to reach more customers into some of the more broad-based segments. As an example, in the last several quarters, we saw more education customers turn on, we saw more research. And as we spoke about earlier in the call, it's still early days on the ramp of automotive. And with that transformation from prior ICE vehicles to electric and autonomous vehicles, we're seeing a large number of new companies and customers that we are serving in all 4 regions.

So it's -- like I said before, this is a part of our strategy. We've been running this for 5 years, and it's helping us to build this base of customers and accounts going forward.

And the only thing I would add to that is, if you look at wallet share, you're exactly right. We've expanded into services to get more of our customers' wallet share. We've expanded with our software offerings, and we have added more solutions up and down the communications ecosystem, which clearly gives us a higher percentage of our customer share.

But it's also important to take a look at our competitors and just go back over the last 1, 2, 3, 4 years and take a look at our growth rates versus others. And I think you'll also see market share gains for Keysight.

Our next question will come from the line of Samik Chatterjee with JPMorgan.

This is Joe Cardoso on for Samik Chatterjee. Just one question for me and circling back to automotive. Within auto, there has been this general excitement around EVs and AVs, both with auto aligned and not aligned companies looking to leverage those upcoming opportunities. Can you touch on the competitive landscape there, particularly in that area of auto and whether you're finding it incrementally tougher relative to traditional automotive world given the potential of new competition? And how is Keysight driving differentiation there?

Yes. Thanks, Samik. I think if you -- on one dimension, you look at the biggest changes going on in auto around EV and AV, as Ron mentioned, in the EV space, it's all about bringing the best precision metrology that we have to measure current and voltage and other basic parameters that enable decision-making on extending ranges. And this is a matter of us making -- configuring our IP to apply to a different application set. And it's one where there's a lot of parallel sets of innovation going on, and we're able to do that today. And it's still very early days in the EV segment but we're getting embedded with a lot of the lead innovators and the larger ecosystem that's forming.

With regard to AV, clearly, 5G is going to be a big factor that's going to impact the autonomous cars just from the connectivity aspect and the entire technology stack that goes with it. And that's where extending our strength and differentiation in 5G into this marketplace continues to give us a unique position of differentiation. Some of the successes we're having is on account of it. And as you saw, we just entered into a partnership with [Decker] as well to continue to promote this new standard approach to test in this marketplace.

So still very early days. We're very pleased with the results this quarter. We had strong growth and second consecutive quarter of double-digit growth in auto, and there's plenty of runway ahead.

And then on the competitive landscape being tougher?

Yes. With regards to the competitive landscape, I mean, clearly, anytime there are traditional competitors that have been on the combustible marketplace that are trying to configure, to try to address this opportunity. But as we think about it, the expertise needed and the IP needed to play in this space longer term, I think we bring a very unique perspective there.

And our next question will come from the line of David Ridley-Lane with Bank of America.

So Keysight came into fiscal year '21 with a backlog built up due to COVID-19 disruptions in the prior year. And year-to-date, you've already built up what I would kind of call an above-average backlog. So how do you see this interplay of kind of delivery timing of supply chain? Do you think that you're able to [complete] around that excess backlog over the next 12 months? Is it something that extends? How should we think about that?

Yes, it's a great question. So again, I'd reiterate -- I'd start by reiterating the points that I've made, which I think we've done a really good job of meeting the needs of our customers and getting them the products that they need in a timing which is satisfactory at least.

I think, as you know, we've built up significant backlog. I think that backlog is going to -- it's going to come down over time. But we're also growing into it, right? The business is significantly larger now than it has been previously. So we would expect to be carrying higher amounts of backlog.

But I don't expect that there's going to be a 1- or 2-quarter flush of material backlog. I think we're going to work it down over time and continue to meet the needs of our customers, working with them on scheduling deliveries as we manage the supply chain constraints and the addition of capacity, which we're still investing in to ultimately bring backlog levels in line with the size of our business.

That does provide a lot of confidence for us to be able to continue to grow our revenue base having such a strong backlog situation that we have.

Got it. And then I think this is the first quarter that you cited O-RAN as a driver for orders. I know there's been -- you've been making investments. There's been a lot of industry interest here. But are you starting to see real tangible orders as a result?

Yes. O-RAN was a strategic bet we made a year or so ago. We were participating with the original O-RAN alliance for a longer time than that. At the highest level, we've long seen that the technology stacks are going to get virtualized to take advantage of the economics and the flexibility the cloud -- that comes with cloud.

And so we -- if you remember, a couple of years ago, we made the acquisition of Prisma, which gave us some unique capabilities, which we were then able to combine with our Ixia acquisition that we made subsequently. And we've launched the Keysight Open RAN architect capability last quarter. And we've received pretty sizable orders already, and we have a very strong pipeline.

And this quarter, we took the Keysight Open RAN architect and have now made it available on the Amazon Cloud as an offering for customers that are coming into this opportunity from a software perspective, so it's software testing software.

We feel very good about our position in this marketplace. I just want to highlight that multiple Open RAN test and integration centers around the globe have already selected us in our KORA offering. And you've also heard -- I think Ron referenced the success we've had with Vodafone selecting Keysight as a partner for design and test. So very pleased with it.

But again, from a time line of O-RAN, this is a long-term trend, one that we're well positioned today, but we'll continue to grow this business over time.

Our next question will come from the line of Adam Thalhimer with Thompson, Davis.

Congratulations. I wanted to ask one question on semiconductors. Can you give us a sense of where we are in the semiconductor cycle for Keysight? And also how much visibility you have there?

I'll take this. Clearly, a very strong quarter, again, building on 4 consecutive quarters of record orders of revenue in the business. We're very pleased with the performance there.

With regard to where we play, we're playing in the wafer test, which is in the front end of the semi process. And given the dynamics that are going on around lithography and the advancements that are playing out, especially driven by 5G and data center applications for 7-nanometer, 5-nanometer and 3-nanometer, I think all of those new node size-based opportunities are still on the very early innings. Because one, those nodes have to get stable and then ramp up. So it's still very early stages there.

So we view the capital spend for those new node sizes to be fairly stable over time. Obviously, there is a part of the business that is about scaling capacity into mature processes, and we think that will continue given this current semi shortages that are going on and demand being high through '22, and it remains to be seen what happens along the term.

We also -- it's important to highlight that given the infrastructure spend that's likely to come into the United States and Europe and other regions looking to localize supply chain, it's one dynamic that's not factored into any of these outlook projections but could have more upside for the semi business.

But again, you look at the end market demand drivers, whether it's new memory, topologies or 5G or data center demand, all of those are feeding into this at this point.

Our next question will come from the line of Rob Mason with Baird.

Several questions already around supply chain, but -- and perhaps I missed it, but did you speak to your own efforts internally to kind of boost capacity? I know production capacity, trying to increase that, at the same time, battling some of the COVID-related restrictions was an effort. Maybe just an update on that front.

And maybe relatedly as well is just, how do you think about the seasonality of the business? We went through this year with kind of muted seasonality for several reasons. That seasonality continuing as we head into -- or kind of muted seasonality continuing as we head into '22.

Yes. Great question. So obviously, we have been and continue to invest in increasing our own capacity. Just as a point, we did $4.2 million of revenue last year.

Billion.

We're going to do $4.9 billion of revenue this year. So we've added significantly to revenue. Last quarter, we did talk about how within our own factories and subcontractors, which we did have some capacity constraints, those items were not a gating item for us this quarter. We've added enough capacity that it was no longer the gating item.

That doesn't mean that we are done investing as we continue to look forward to the future growth of our business. We're continuing to make investments in further capacity expansion. But right now, I feel like we're doing a good job of staying ahead of the curve. And certainly, particularly given that there are some supply chain constraints that potentially is relieving a little bit of the -- a little bit of the pressure there.

On the seasonality question, I've answered this question many times over the years. And when I sit back to model our business at the beginning of any year, we tend to think of coming off of Q4 is our biggest quarter of the year. So we model sequentially down in Q1, up in Q2, down a little bit in Q3 and then a big finish in Q4, the highest quarter of the year. That's how I would sit down to model our business.

As we talked about all through this year, we expected because of the rebound from COVID and then more recently with some of the supply chain constraints and the need to add capacity, we expected that seasonality to be more muted this year than it's historically been. And I think that's proven out here over the last several quarters.

I think as we look forward, at least over the next couple of quarters, I expect that muted seasonality to remain intact. That doesn't mean there won't be any. I just think that the swings will be less than they typically are. And beyond that, it's hard to call.

And our next question will come from the line of Mark Delaney with Goldman Sachs.

The company cited trade restrictions with China as a headwind to the growth rate that you reported. I was hoping you could elaborate a bit more on what you've ended up seeing and some of the puts and takes in the context of maybe there are certain customers you're not able to ship to. But to what extent have you been able to offset some of the -- some of those trade-related headwinds either as you focus more of your own resources on other customers or some of the other customers perhaps took market share?

Mark, do you want to take that? Or...

Yes. Yes, I'll be happy to. Hey, Mark. So as I mentioned before, we did see some uplift from the COVID recovery in certain segments that were really more affected by the impact last year and the early part of this year. So you would consider that to be automotive, manufacturing supply chain, the things we talked about, right, education and research and then our sales into some of the broad customers, both direct and indirect. So that's a dynamic that we certainly experienced.

We had some pull-in, as we talked about before, in semiconductor, but it's small and it really gives us this longer visibility through the forecasts and funnels going out many, many quarters as that is a slower moving process with fabs and so forth.

And -- but again, most of our growth in the quarter still comes from the continuing investments in the areas that we're talking about for next-generation technologies, across commercial comms and aerospace, defense and e-mobility. And we've done a great job of capturing those in all regions, including China where obviously that's where the headwinds originate. And this last quarter, we overcame them again, sustaining top line growth in China, double-digit growth when you exclude the trade impact. And it's really a testament to our ability to pivot to the broad-based business that's available to us in China and the ability to capture that throughout the various cycles.

So semiconductor, again, automotive, general electronics, so we've not only pivoted in China, but we've also captured this around the world.

And getting more specifically with regard to the trade headwinds, there's no doubt there's been some more companies that have been added to the restricted list. But the team has done an excellent job of still providing growth despite that and making up for, let's say, large sales that were a headwind going into this year. And most of that is behind us, and we look forward to the future.

Yes. Just one more to add on that. Q3 was the last quarter of strong headwind from one customer in China. So it's going to be a little better, going forward.

Just a follow-up question on supply chain and specifically with Malaysia. Given the vaccination rates that you mentioned within your factory, can you talk about to what extent you can operate at normal or near normal levels of capacity in Malaysia because of those vaccination rates? Or are there still restrictions on how much you can have operating in Malaysia?

Yes. We're in Penang, in Malaysia. Some of the bigger outbreaks that they did have in Malaysia first occurred in the southern part of Malaysia, not in Penang, where we are.

But regardless of that, we had a very massive effort to not only vaccinate our employees, but also folks that we work with, our partners, some of our contract manufacturers, our shippers that come in, anybody that gets in contact with us.

And we have over 95% that have received the first dose as of beginning of this week. This week, they were getting the second dose. So that feels very good. That's not a constraint right now. But as the orders grow, we'll continue to build that.

The constraint is just getting some lower-level components in certain areas. But we feel very good about our production capacity that we have in Malaysia as well as what we have in the other facilities where we do manufacture, as we do some manufacturing in the U.S., we do some in Germany. And altogether, it's all built into the guide.

And our next question will come from the line of Brandon Couillard with Jefferies.

Neil, just a clarification just on the 4Q guide. I mean if the Huawei headwinds roll off in the fourth quarter, I'm a little surprised that the implied revenue growth in the fourth quarter wouldn't be better than kind of low single digits, if that's the case, which would imply a deceleration on 2- and 3-year stack comps. It doesn't sound like the end markets have changed all that much. You talked about supply chain constraints here and there, but you seem to be managing it fairly well. So am I missing something here? Or are you embedding perhaps a little more conservatism around one particular end market?

Yes. No, I think as we've gone through this year, we've been building our ability to ship and our ability to drive incremental revenues as we've gone through the year 11 80 Q1; 12 20, Q2; 12 46 Q3, we're guiding to 12 60 Q4. So we're making some stepped-up progression.

In terms of the year-over-year growth rates, obviously, the Q4 of last year was the kind of the big bounce back quarter after our factories reopened up and reramped following the initial COVID shutdown. And so we have an unusually tough compare from a year ago. And frankly, not just on the revenue line, but we've talked about the extraordinarily favorable mix that we saw in Q4 of last year that drove gross margins and operating margins high.

And so I think if you're thinking about it from that perspective, I'd just point really to that tough comp as something that's going to mute growth rates here in the fourth quarter. But I think we continue to make progress, adding capacity, continue to making progress in terms of ramping our revenue, and we're really well positioned as we look forward to FY '22.

Okay. And then maybe I missed this, but did you give the software and service revenue growth for the third quarter?

We did not, but both businesses continue to grow very, very strongly here in the fourth quarter. And we're very pleased with the progress we're making in both areas, double digits for both lines of business.

Thank you. And with that, that will conclude today's question-and-answer session. And I'll turn the call over to Jason Kary for closing comments.

Thank you, Holly, and thank you, everyone, for joining us today. We look forward to speaking with many of you at the upcoming conferences and wish you all a great day and a great evening.

Once again, we'd like to thank you for your participation on today's conference call. You may now disconnect.