Q1 2025 Keysight Technologies Inc Earnings Call
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Joel: Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal First Quarter 2025 Earnings Conference Call. My name is Joel and I will be your operator today. If at any time during the conference you need to reach an operator, please press star zero.
Joel: This call is being recorded today, Tuesday, February 25, 2025, at 1.30 p.m. Pacific time. I now hand the call over to Harry Blount, Head of Investor Relations. Please go ahead, Mr. Blount.
Joel: Thank you and welcome everyone to Keysight's first quarter earnings conference call for fiscal year 2025. My name is Harry Blount. I have long admired Keysight as a market leader in accelerating innovation and I'm delighted to join Keysight as head of investor relations.
Speaker Change: Joining me are Keysight's President and CEO, Satish Dhanasekaran, and our CFO, Neil Dougherty.
Speaker Change: In the Q&A section, we will be joined by Chief Customer Officer Mark Wallace. The press release and information to supplement today's discussion are on our website at investor.keysight.com under Financial Information and Quarterly Reports.
Today's comments will refer to non-GAAP financial measures.
Speaker Change: We will also make reference to core growth which excludes the impact of currency movements and acquisitions or divestitures completed within the last 12 months.
Speaker Change: The most directly comparable GAAP financial metrics and reconciliations are on our website, and all comparisons are on a year-over-year basis, unless otherwise noted.
Speaker Change: We will make forward-looking statements about the financial performance of the company on today's call.
Speaker Change: These statements are subject to risks and uncertainties and are only valid as of today.
Speaker Change: We assume no obligation to update them and encourage you to review our recent SEC filings for a more complete view of these risks and other factors.
Satish Dhanasekaran: Lastly, management is scheduled to participate in the upcoming investor conferences hosted by Susquehanna Financial Group and Morgan Stanley and now I will turn the call over to Satish.
Satish Dhanasekaran: Good afternoon, everyone, and thank you for joining us today. My comments will focus on three key headlines.
Satish Dhanasekaran: First, Keysight delivered strong first quarter results, revenue of $1.3 billion and earnings per share of $1.82 both exceeded the high end of our guidance.
Satish Dhanasekaran: Co-revenues grew for the first time in six quarters reflecting strength in the communication solutions group and stabilization in our electronic industrial solutions group.
Satish Dhanasekaran: Second, orders grew year-over-year for a second consecutive quarter, up 4% to $1.3 billion.
Satish Dhanasekaran: We're seeing incrementally positive signals in our sales funnel and customer engagements.
Satish Dhanasekaran: Our view of 2025 remains unchanged. We continue to expect gradual recovery even as we monitor the policy changes contemplated by the new administration in the United States.
Satish Dhanasekaran: Third, we're well positioned for the future. The world's most technologically advanced companies trust us to deliver market-leading products and solutions at the physical protocol and application layers.
Satish Dhanasekaran: The underlying technological trends of more memory, faster processing, greater bandwidths, and with lower power remain intact.
Satish Dhanasekaran: We are engaging with our customers earlier and more broadly, which gives us confidence in our ability to create value for our stakeholders.
Satish Dhanasekaran: Now, let's begin with an overview of Keysight's first quarter business performance.
Satish Dhanasekaran: Communication Solutions Group revenue grew 5% reflecting continued momentum in wireline, stability in wireless, and growth in aerospace defense and government. Orders grew for the third consecutive quarter driven by growth in both wireline and wireless.
Satish Dhanasekaran: In WireLine, demand remains strong for a physical layer and AI workload emulation solutions and we saw record orders again this quarter.
Satish Dhanasekaran: Keysight is enabling the expansion of the AI data center network and the design of electrical and optical technologies for higher speeds and bandwidth.
Satish Dhanasekaran: We continue to see strong engagement from a broad ecosystem, chipset designers, network equipment manufacturers, and hyperscaler customers.
Satish Dhanasekaran: At DesignCon, Keysight demonstrated an industry-leading 400 gig per lane test solution enabling 3.2 terabit speeds along with industry-leading low-power DDR6 memory compliance tests.
Satish Dhanasekaran: We believe AI will be a long-term secular tailwind for the design of next-generation technologies in the network, data center, and communications ecosystem.
Satish Dhanasekaran: Our wireless business performed in line with expectations and consistent with the stability of the past two quarters with ongoing activity related to standards progression in 5G advanced non-terrestrial networks and research in early 6G.
Satish Dhanasekaran: We saw relative strength in network infrastructure with ongoing innovation in radio access networks and early 6G while demand remains muted in the smartphone supply chain.
Satish Dhanasekaran: In Q1, we launched our flagship PNA-X Pro network analyzer to enable the design of advanced components and modules for early 6G research, aerospace defense, and non-test-shell networks.
Satish Dhanasekaran: This solution delivers high performance capabilities and unmatched measurement speeds while dramatically improving the efficiency of our customers' design workflows.
Thank you.
Satish Dhanasekaran: At the upcoming Mobile World Congress, we will be demonstrating PNAX Pro along with other solutions addressing AI, 6G, open radio access networks, and satellite connectivity, many of which will be highlighted in collaboration with industry-leading customers.
Satish Dhanasekaran: Turning to aerospace defense and government, revenues grew to a first quarter record with strength in both the U.S. and Asia. The funnel of opportunities remained strong in EMSO, secure communications, space and satellite, while orders were down in the quarter due to ongoing continuing resolutions.
Satish Dhanasekaran: Keysight continues to develop differentiated RF and microwave capabilities for security applications such as radar, spectrum operations, and signal monitoring. This quarter, Keysight had a notable win with a European Prime for advanced threat simulation solution.
Satish Dhanasekaran: In semiconductor, fab capacity investment and AI-driven demand for advanced node technologies, high bandwidth memory, and silicon photonics continue to drive strong customer engagement.
Satish Dhanasekaran: New fab projects are ramping, helping drive a third consecutive quarter of strong order growth for our parametric wafer test solutions.
Satish Dhanasekaran: In automotive, market conditions remain challenged, reflecting muted activity in manufacturing and EV battery development.
Satish Dhanasekaran: Despite the near-term headwinds, customer engagement and innovation remain high in R&D for software-defined applications and autonomous driving.
Satish Dhanasekaran: Next generation autos will require optical technologies for high bandwidth data transfer and processing within the vehicle.
Satish Dhanasekaran: This quarter, Keysight partnered with Fabulous Semiconductor Company to deliver a new multi-gigabit optical Ethernet test solution.
Thank you.
Satish Dhanasekaran: In general electronics, orders grew for the second consecutive quarter. Customer spending in our industrial end markets was driven by high-speed PCB and connectivity applications and inventory normalization in the distribution channel.
Satish Dhanasekaran: We also saw strong growth in advanced research, particularly in Europe and Asia.
Satish Dhanasekaran: We have made strategic progress in growing software and services, which accounted for approximately 40% of Keysight revenue, while recurring revenue was approximately 31% of total revenue.
Satish Dhanasekaran: We're seeing growing customer engagement in our design engineering software solutions.
Satish Dhanasekaran: and ESI, we saw new demand in aerospace defense as well as industrial customers.
Satish Dhanasekaran: In closing, we're pleased that we've returned the company to growth, our robust innovation pipeline, strategic customer relations, and strong operating and capital discipline position us well to create value for all our stakeholders.
Satish Dhanasekaran: I'd like to sincerely thank our employees once again for all their outstanding contributions, commitment and track record of execution.
Satish Dhanasekaran: With that, I'll turn it over to Neil to discuss our financial performance and outlook.
Neil Dougherty: Thank you, Satish, and hello everyone. First quarter revenue of $1,298,000,000 was above the high end of our guidance range and up 3% on a reported and core basis.
Satish Dhanasekaran: while orders of $1,263,000,000 were up 4% on a reported and core basis.
Backlog finished the quarter at 2.3 billion dollars.
Satish Dhanasekaran: Looking at our operational results for Q1, we reported gross margin of 65.8%.
Satish Dhanasekaran: Operating expenses of $500 million were up 2% year-over-year and Q1 operating margin was 27%.
Satish Dhanasekaran: Turning to earnings, we achieved $317 million of net income and delivered earnings per share of $1.82.
Satish Dhanasekaran: Our weighted average share count for the quarter was 174 million shares.
Moving to the performance of our segments.
Satish Dhanasekaran: The Communication Solutions Group generated first quarter revenue of $883 million, up 5% year-over-year on a reported ANCOR basis.
Satish Dhanasekaran: Commercial communications revenue of 572 million dollars and aerospace defense and government revenue of 311 million dollars each increased 5 percent.
Altogether, CSTE delivered 68% gross margin and 27% operating margin.
Satish Dhanasekaran: The Electronic Industrial Solutions Group generated revenue of $415 million, down 1%, or flat on a core basis.
Satish Dhanasekaran: EISG reported 61% gross margin and 27% operating margin, largely due to a higher mix of software.
Satish Dhanasekaran: Moving to the balance sheet and cash flow, we ended the quarter with $2 billion in cash and cash equivalents, generating cash flow from operations of $378 million and free cash flow of $346 million.
Satish Dhanasekaran: We repurchased 450,000 shares this quarter at an average price of approximately $167 for a total consideration of $75 million.
Now turning to our Outlook.
Satish Dhanasekaran: We expect second quarter revenue to be in the range of $1,270,000,000 to $1,290,000,000 and Q2 earnings per share in the range of $1.61 to $1.67.
Satish Dhanasekaran: based on a weighted diluted share count of approximately 174 million shares.
Satish Dhanasekaran: As a reminder, Keysight's historical first to second quarter revenue seasonality will be muted by the cadence of the ESI business.
Satish Dhanasekaran: Looking to the second half, the macroenvironment is expected to continue to be mixed, including uncertainty stemming from potential U.S. policy actions.
Satish Dhanasekaran: Despite this, our base case scenario for gradual recovery and FY25 remains unchanged, with assumptions for revenue growth at the low end of our 5-7% long-term target and earnings growth consistent with our 10% target.
Satish Dhanasekaran: In closing, we are executing well and capitalizing on the recovery as it evolves across our end markets.
Satish Dhanasekaran: Our broad and diverse customer base, expanding solutions portfolio, deep customer engagements, and robust innovation pipeline provide a solid foundation for the year ahead. With that, I will turn it back to Harry for the Q&A.
Harry Blount: Thank you, Neil. Operator, will you please give the instructions for Q&A?
Thank you very much.
Speaker Change: Absolutely. Ladies and gentlemen, if you would like to ask a question, please press star 1. We ask that you please limit yourself to one question and one follow-up. To withdraw your question, please press star 2.
Satish Dhanasekaran
Speaker Change: The first question is from the line of Samekh Chatterjee with J.P. Morgan. Your line is now open.
Hi Priyanka Thapa on Prasanna Chatterjee
Speaker Change: So, my question is, regarding the upside from the commercial communications, well hi!
Yeah, so my question is on the commercial communication segment.
Speaker Change: And regarding upsides to that segment, could you provide what you anticipate that kind of breakdown between the contribution from wireline versus wireless will be since you had this quarter stability in wireless and you had a lot of strong growth in wireline due to the AI factors?
Speaker Change: Yeah, I think, you know, you characterized it very well. We saw stability in wireless.
Speaker Change: and some uptake in our infrastructure portion of the wireless business as operator CAPEX outlook is getting better.
Speaker Change: So, you know, the smartphone ecosystem continues to be muted in its recovery, so that's the stability picture in wireless. But really the highlight was the strong growth in orders and demand that we saw for our wireline offerings driven by AI.
Speaker Change: And what do you anticipate that trend to be in the future if anything? Do you think it's still going to be a wireline stable or do you expect an uptick if the smartphone ecosystem improves?
Thank you.
Speaker Change: You know, it's at least in our short term, we think the wireless continues to be stable. That's sort of our base case thinking.
Speaker Change: There could be some upside as spending and infrastructure ramps in that area. But we feel very strongly that the innovation drivers in AI continue to be robust along with the investment outlook that our customers have shared with us today.
Thank you.
Speaker Change: kind of noted continuing resolutions kind of as a reason for order weakness on aerospace and defense, but just kind of how you're seeing kind of the current budget environment around federal
Speaker Change: And then maybe as a second question, is there any way to kind of contextualize the order of strength you saw on kind of wireline specifically that would kind of allow us to kind of, you know, contextualize some of the strength you're talking about on AI? Thanks.
Speaker Change: I will, Mehta, so let me start with the aerospace defense and then we get to the other piece.
Speaker Change: You know, I think, look, it's a business I've said before, really difficult to call on every quarterly basis, but you take a long-term view.
Speaker Change: It's probably one of our most stable businesses to call because the defense budgets keep going up with GDP, and an increasing portion of that is towards technology modernization, or what we call defense modernization.
Speaker Change: So, you know, no change to that long-term trend. If I look at the pipeline of opportunities where we are engaged in, continue to remain strong. I point you to some data points, right? The backlog of prime contractors is at a record level.
and the demand for solutions from our customers.
Speaker Change: remain strong. I think we're just balancing a typical continuing resolution issues in terms of timing of those deals.
Speaker Change: combined with administration change. So any any minor near-term perturbation typically tends to get worked out in a few quarters. That's what we're seeing. But again, we had a strong revenue growth.
Speaker Change: this quarter from our aerospace and defense business as we deliver some of the solutions that we have booked last year as well.
With regard to AI...
I would say that the supply chain environment for AI
Speaker Change: remains constrained as capital flows through and we're seeing a strong uptick in manufacturing for these sorts of high-end capabilities and we're well positioned and we're capitalizing on those at this point.
Speaker Change: But equally exciting for us is the longer-term opportunity coming in multiple dimensions, you know, for key sites, products, and solutions. And I would say all the way from the accelerated
Speaker Change: adoption of technology standards such as PCIe Gen 7, you look at LPDDR6, you look at the 400 gig to 800 gig to, you know, increased activity in R&D around the terabit speeds.
Speaker Change: All of that really creates a very robust pipeline of opportunities that really matches the areas that we had invested in last year and were able to capitalize on that.
Speaker Change: And, you know, we feel good about the growing number of collaborations we have in the space with customers, because the challenges that they're facing are quite complex as they start to put some of this CAPEX to work and start implementing some of these
Speaker Change: high-speed AI clusters, I think we're making a meaningful contribution and that's only going to grow with time.
Thank you. Thank you.
Thank you.
Speaker Change: The next question is from Mehta Hossaini with Susquehanna. Your line is now open.
I'm Mandy.
Sorry, I had a hard time unmuting. Apologies there.
Speaker Change: a couple of follow-ups from me, one near term, one short, longer term. Let me start with the longer term. Neil and Satish, when you're looking at your R&D activity, looking over the next...
Hello Commercialization over the next several years.
How should we think about...
Satish Ji. Thank you.
Speaker Change: versus satellite communication. Could we at some point in the latter part of this decade reach a point where
Speaker Change: There will be more of a commercialization of satellite com, and would that be some sort of a, I don't want to say substitution, but complementing the evolution of 5G? And I have a follow-up.
Speaker Change: Yeah, I think that's a fair characterization, Mehdi, that, you know, satellite communications, especially non-terrestrial networks, and that ecosystem growing in its contribution both for security and for commercial applications.
Speaker Change: It's an incremental opportunity for us, if that's the way you want to think about it.
it for a wireless business.
Speaker Change: Clearly, the other major technology driver that we're seeing increased R&D investments at this point, more R.
Speaker Change: then D, but as things flow, eventually leads to standardization and leads to development and deployment to come.
Speaker Change: Sure, but what's the net impact on Keysight? Would that actually be incremental for Keysight? Zero, or is no, neutral, net neutral for Keysight opportunities?
Satish Dhanasekaran
Whenever you're staring at a new generation of technology,
I think, you know, it's safe to say that one...
Speaker Change: One doesn't see, you know, greatest resolution way ahead of time, but I can tell you just from looking back at history of every business, you go back to 3G.
4G and 5G.
Speaker Change: And there is no doubt that the SAM, if you think of it over a...
Speaker Change: longer period of time has grown just because of growing complexity. And not to mention, you know, we're still, you know, quite early in our innings in terms of expanding our capabilities and really deploying the full extent of the capabilities of the company.
Speaker Change: That's been our focus, and I think you should take away that our ability to invest in the downturn last year
Speaker Change: is going to mean that we did not lose any steam. In fact, we continue to grow stronger in terms of our ability to say yes to our customers, participate in early pilots.
Speaker Change: So I feel good about our position, hard to really say exactly how big the SAM will be, but if history is any gauge, the R&D opportunity will definitely be bigger, and we're prepared to capitalize on it.
Speaker Change: Thank you. The next question is from Adam Thalheimer with Thompson Davis. Your line is now open.
Hey, good afternoon, guys. Nice quarter.
Speaker Change: Thanks Adam. Can you give a little more color? You talked about a positive sales funnel and encouraging customer engagements.
Speaker Change: I'm just curious if that's an indicator that we might be closer to a mixed demand environment becoming a solid demand environment.
Yeah, Adam, um...
Adam Thalheimer: What I what I can say is that it's incrementally improving since the last time we spoke three months ago And it's in line with what we've been speaking about which is
Speaker Change: you know, the steady, gradual improvement and recovery here in 2025.
Speaker Change: And, you know, we've spoken about our funnel, which goes out about six months, and that six-month funnel is improving in multiple ways. The first is new funnel intake, which is the most important to me. That's new business coming in through the pipeline.
And we see that improving and it's solid as.
Thank you. Thank you.
Neil Dougherty, Satish Dhanasekaran
Speaker Change: how much business is created and closed in a particular quarter. And then, obviously, the third part, which is the end goal, is having a big funnel. And the funnel is growing, and our short-term funnel, meaning
looking out three months.
is in support of our QT Guide.
Speaker Change: So, I think the summary is, we have better visibility than we did three months ago, our signals are generally moving more positive incrementally, and it supports our thesis of a gradual recovery during the year.
Good color, Mark, and then.
Speaker Change: Also, can you comment on how EV sales are trending, what the expectations are there?
Speaker Change: Which part? How easy are sales? How easy are sales? Easy.
Speaker Change: Our focus is really around R&D for battery development has remained constrained.
We see activity in e-mobility overall.
Speaker Change: So as the hardware and software architectures in the automobiles begin to disaggregate in terms of software defined vehicles
Speaker Change: and communication speeds increase. We are seeing an uptick in that focus and investment from our customers, but right now as far as what we're seeing in the last quarter and what our funnel tells us is that EV and battery test remains soft.
Auto manufacturing, as well, remains soft.
and Siddhartha Mukherjee. Thank you.
Thank you.
Speaker Change: The next question is from David Ridley Lane with Bank of America. Your line is now open.
Speaker Change: Good afternoon. Can we get an update on sort of the performance of the ESI group, sort of following on that question. Is the software aspect also facing budget constraints and so forth? And how are you progressing on sort of your margin targets for that acquisition?
that kind of a realization of synergy perspective.
Speaker Change: The, as you know, it's a high recurring revenue business, and I think we saw renewal rates in the quarter were consistent with expectations. I do think the relative softness in the auto markets that
Speaker Change: Mark just talked about, did unfavorably impact our upsell to those auto customers within the quarter. But that was then offset, as we said in our previous remarks, as we started to get traction with aerospace defense and industrial customers.
kind of newer markets for for the ESI portfolio.
Bye.
Speaker Change: Thank you. And then you have two pending acquisitions coming out of the ANSYS-Synopsys deal, right? You have the Optical Solutions Group from Synopsys, and then on the other side of the house you have Power Artists, but a software from ANSYS.
Speaker Change: Are these deals contingent on answers going through and how meaningful are these two on a combined basis?
Speaker Change: just in terms of revenue orients or some way of quantifying what's in the pipe.
Speaker Change: Yeah, the two transactions are contingent on the closure of the Synopsys Ansys transaction and to this point we have not sized.
Speaker Change: those two transactions, but we're excited to add them to our design engineering software portfolio. We have business in both power management as well as optical, and so they're complementary to the physical air tools that we currently have inside our portfolio.
Thank you.
Speaker Change: The next question is from Mark Delaney with Goldman Sachs. Your line is now open.
Speaker Change: Yes, good afternoon. Thanks for taking the questions. Mark, let me give you my best and wish you well in your upcoming retirement and very congratulations on the new goal with KeyState.
Well, thank you, Mark. Appreciate it.
Speaker Change: can help us understand a bit more what you're doing from an OPEX perspective. Should we still expect some investments over the course of the year, and if so, how much?
Speaker Change: Yeah, so I show total FX up about 2% on a year-over-year basis, Q1 versus Q1.
Speaker Change: at the Christmas holidays, as well as the Chinese New Year holidays, falling as Q1. Significantly lower PTO usage in the end of quarter, which is, which also puts
Speaker Change: upper pressure on on on OPEX. I think as you think about investments
Satish Dhanasekaran: and Satish already alluded to this, our ability to continue to keep core programs on track during the downturn and now potentially, as the business returns to growth, start to fund some incremental dollars into things like 6G, quantum computing, and capturing this AI market opportunity for us.
Satish Dhanasekaran: is something that we're excited about and there's no shortage of opportunities for us to continue to layer on incremental investment.
Neil Dougherty: Thank you a lot, Neil. It's in about 40% incremental margins, so that's still the right framework if you guys go to the top line in single digits for the year.
Satish Dhanasekaran: Yeah, I would say on average for quarters where we're growing 5% or better, you can think about that 40% amount.
Speaker Change: Okay. And my other question was just around gross margins. I think it went down a little bit year on year. Maybe you could speak a bit on what was driving that in terms of factors like price, cost, and mix. Thank you.
Speaker Change: Yeah, it's mostly mix related. You know, if you go you go back and look at the trend lines, you know, we were still to some extent benefiting from the sale of backlog, even into into Q1 of last year, and then we saw
Speaker Change: a pretty significant step function down in the Q2, Q3, Q4 of FY24. So this was our last really tough compare from a gross margin standpoint, the gross margin performance.
Speaker Change: that we just put up in Q1 is the highest gross margin performance we've had in the last four quarters, is aided a little bit by the incremental ESI revenue. But again, relative to the past three quarters, some favorable mix, but compared to a year ago, the mix was less favorable.
Speaker Change: I think if just to add a little bit more color, you look at the businesses which are a lot more R&D indexed mark in the company and CSG, the gross margins are
68%
Speaker Change: In the EISG business, as we have talked about, there's a wide dispersion.
Speaker Change: between the manufacturing and R&D businesses, and that's work that Jason's new role is going to continue to do. But if you look at that portfolio last year, that was at 65%. Just the mix was so much more favorable leading to this compare at the company level.
Speaker Change: For longer term, we feel good about the opportunity to continue to bear on more R&D contributions to our customers and create greater value for them, and I believe that value as we roll these solutions out.
Thank you.
Speaker Change: The next question is from Matt Nicknam with Deutsche Bank. Your line is now open.
Speaker Change: Hey guys, thanks so much for taking the question. Just two if I could. First, on orders, maybe Neil, if there's any...
Speaker Change: framework in terms of how to think about fiscal 2Q orders sequentially just in light of a gradual recovery in the business but some moving parts with ESI.
Speaker Change: He referenced some softness in orders tied to ongoing continuing resolutions. I'm wondering if maybe Satish, if you can help frame any conversations, just any sort of sizing in terms of potential risk from DOJ in terms of just government efficiency and what's been going on in D.C. with the new administration on your business. Thanks so much.
Speaker Change: Thank you. Yeah, so why don't I go first and I'll deal with the sequential question.
Speaker Change: You know, if you think about this business historically, we would tend to think about Q1 to Q2 season. Now, this is excluding ESI.
Speaker Change: is kind of up mid-single digit sequentially, and then that would be offset then by a pullback in ESI that recognizes close to 50% of their orders in the first quarter, in Keysight's first quarter, with the remaining 50 to 55% spread relatively evenly over the remainder of the fiscal year.
Speaker Change: So, and I think that is a fair way to think about it going forward.
Many of our customers continue to believe that.
Speaker Change: The programs that are already in their backlog from our prime contractor customers.
Speaker Change: is at record levels and there's unlikely to be a big change to that picture.
Speaker Change: So, those things that are already in flight, likely to continue on, and that's a pretty big at a record level, as I mentioned, so that's number one.
Speaker Change: Number two, you look at the global picture in Europe and Asia.
Speaker Change: and you start to see a scenario which is likely to emerge where, given the geopolitical realities, their defense spending as a percentage of GDP is likely to go up.
Speaker Change: As a matter of fact, if you just watched today, the UK confirmed taking up the defense spending just today as well. So I think that's likely to be the trend, and given our technology and capabilities, I think we'll continue to be in a good position to capitalize on those opportunities.
Speaker Change: With regard to the direct government spending, the RDT and E-Line item is something that we're watching for and will remain, but you know it's unlikely that we see a scenario where there's a significant cut to technology advancement.
with regards to security and defense.
Speaker Change: But that's our base case thinking. That's sort of what our customers are telling us as well, but no one really knows until these things play out. So we're continuing to monitor that.
Thank you.
Speaker Change: Thank you. The next question is from Aaron Rakers with Wells Fargo. Your line is now open.
Aaron Rakers: Thanks for taking the question and congrats on the good results. I want to go back to some of the prior questions around margin. First of all, Satish, I want to make sure I'm clear in what you're saying. On EISG, as we see some recovery in that business, do you think that we can...
Speaker Change: consider a gross margin back into that mid 60% range. And then, Neil, on operating margin, I know that you had outlined 31 to 32%. I think that target all the way back in 23 at the analyst day.
Aaron Rakers: You know, if we continue to see kind of a 5% growth profile or growth in that range of 5 to 7, do you think it's conceivable that, you know, we could still see that targeted gross margin of 31 to 32 looking into 26?
Aaron Rakers: Yeah, okay. I'm going to explain and address both those questions. So I think as it relates to EISG, it's going to be mixed dependent. I do think it's likely that we take a little bit of time, again, excluding ESI, to climb back to the gross margin levels that we were putting up in Fiscal 23, prior to the addition of ESI running north of 60%.
Aaron Rakers: We'll see it's very mixed dependent as Satish has alluded to and we've talked about many times It has a broader dispersion of gross margins within that portfolio So it really depends on what the nature of this recovery is and which businesses are up relative to others
Aaron Rakers: with regard to your, remind me of your second question real quick.
Aaron Rakers: Yeah, here it is. With regard to operating margin and the 26 targets, I've said previously that we have not lost sight of that 31 to 32 percent operating margin targets. That still remains our goal. We are likely going to slip on the FY26
Thank you. Bye.
Aaron Rakers: achievement of that, particularly if the scenario you lay out plays out, which is 5% growth, you know, for multiple years. In that case, you could think about 5% growth, 40% incrementals and do rough math on how long it takes to get back.
Aaron Rakers: I think we're optimistic that at some point we get a little bit more of a bounce back that allows us to accelerate that momentum. And then certainly, while not contemplated at the time, but the closure of pending acquisitions and our ability to realize synergies on these high gross margin businesses may ultimately help us to achieve those objectives.
Neil Dougherty: The other thing worth highlighting to Neil's point is, while there are gross margin differences fundamentally between the two groups, we have tremendous organizational synergies between the work we do for our customers.
Neil Dougherty: And so you will see even this quarter, even with the gross margin differences, the operating profits between the...
two groups were spot on, so 27 percent.
Thank you.
Speaker Change: The next question is from Tim Long with Barclays. Your line is now open.
Tim Long: Thank you. Satish, I was hoping we could go back to the AI business. If you could just maybe double click on that a little bit. I think in the past you've talked, I know you can't really quantify kind of the scale of that business currently, but I was hoping you could kind of walk us through the top three or four.
Tim Long: use cases and kind of where you are with, you know, customer base and, you know, increasing
Tim Long: new use cases, just trying to get a sense of what the tail.
Tim Long: will look like for the AI business. And then the follow up would be
Tim Long: on software and services. It looks like we got to about 40%. It's been a pretty
Tim Long: steady climb for recurring revenues of 30% or 31%. Could you talk a little bit about how we should think about that transition going forward? Should it still be this kind of slow and steady up and to the right, or is there something that would accelerate that transition?
Well, let me take the first one.
Tim Long: Well, there's a lot of puts and takes in the near term, and I'll just say, take a future state here and say, look, we have about 11,000 data centers today in the world consuming 55 gigawatts.
Tim Long: of Power. In the next few years, you know, there's an additional 63 gigawatts projected of data centers that are going to go online. Just let's think about that as a fact.
Tim Long: Then you overlay on top of it, you know, this difference between training and and inferencing and therefore all of the edge and inferencing applications that's going to grow.
Tim Long: We're already seeing signs of increased processor designs, AI, accelerator cards.
Tim Long: and then you layer on reasoning and inferencing applications. So the long-term picture here is pretty robust for us. And we see that picture. We see our customers moving towards that picture and we're in a great position to be able to intercept that.
and Enable Your Innovation.
Tim Long: And I would say, you know, in the near term, we're participating meaningfully in the compute side of things.
the two nanometer...
Tim Long: push that's happening. Our semi-business had a strong quarter again and we're also working with customers on silicon photonics.
Tim Long: which is a very promising technology to come. This is an investment we made about 18 months ago to work with customers we noted on a call and it's proving out to be one of the good bets that we've made, the positions as well, to participate meaningfully in the compute side of things.
Tim Long: You look at the memory, you know, HBMs, again, DDR67, again, areas that we participate today, you look at networking, this move to higher speeds.
Tim Long: testing because of the cost of failure of these interconnects is very high when you put it in an AI cluster and again that's an area where we're meaningfully participating. On the emulation side
Tim Long: We've launched this AI data center builder, which is our first platform to emulate high-scale
AI Workloads
Tim Long: that allows customers to get a meaningful insight into the time utilization, latency, and cost-to-train AI model. So we're participating up and down the stack.
Tim Long: Again, congruent with our strategy, we feel like we're well positioned in the short and medium term and really see this long-term bigger opportunity that I'm very excited about.
Tim Long: And then with regard to the second question, you know, we've always from the starting of the company felt like, you know, as a solutions company,
Tim Long: We're really focused on this software-centric transformation, as we call it. That's a core part of our transformation. We identify areas where we can add meaningful contribution to help our customers in a sustainable way.
Tim Long: And obviously, we see 40% as a milestone in that journey. And we're not done by any means. I think there is this organic capabilities that will continue to launch more new product introductions. I look at
Tim Long: are hardware introductions to software introductions ratio or software introductions far outpaced.
Tim Long: our hardware introductions because it does take longer to launch hardware than software. So that's that's feeling good and then as Neil alluded to earlier as we start to
Tim Long: bring in new capabilities that some of them we've announced with the Synopsys and Ansys to be to be played out still We will start to expand our contributions in the design space We'll continue to contribute to higher recurring revenue
Thank you.
Speaker Change: The last question is from Rob Mason with Baird. Your line is now open.
Rob Mason: Yes, good evening. Thanks for taking the question. Satish, even in your last response, you mentioned your participation, where you're participating in Semiconductor, and I think earlier you talked about
Rob Mason: third consecutive quarter of, you know, good parametric test orders. I'm just, you know, I'm curious if you're starting to build some backlog in that business and if that's the case, if you have, you know, what's your visibility on revenue conversion for that?
Rob Mason: Yeah, I mean, so we, as you noted, multiple quarters of growth here in the parametric test side of this business and continue to have a favorable outlook on that opportunity as we look forward given some of these new fab opportunities that are coming online. We have built some backlog over the last three quarters.
Rob Mason: obviously, but again, reminding you of our primary order acceptance window is that we're accepting opportunities that are shippable within six months, so the conversion of those orders into revenue is relatively short.
Thank you.
Speaker Change: Understood. Just as a follow up, just could you touch on your business within China in general, you know, what you saw, how you saw business trend during the quarter? Obviously, it's, you know,
Speaker Change: some geopolitical volatility probably. I know in the past when things have emerged, you know, obstacles have emerged, you've been able to pivot.
Speaker Change: to new opportunities. I'm just curious if you're finding yourself needing to pivot in the current environment, and if so, what are you leaning into?
Speaker Change: First and foremost, I would say I was just in China a few months ago, the strength of our customer relationships.
continues to be strong with the geopolitical...
Speaker Change: you know, trade restrictions. We've sort of used to a one to two point headwind.
Speaker Change: post-Huawei which happened a few years ago on a continuous basis and so that's sort of the pivoting of, you know, when you call it pivoting of our focus to customers that we can transact business with.
Speaker Change: It's also probably not a huge surprise to learn that many of China's customers have a Go global strategy.
Speaker Change: And that's something that we're through the relationships we have with them, we're supporting their global efforts, whether it is relocating their manufacturing to Southeast Asia or parts of
Speaker Change: and North America. So, I mean, at the end of the day, I think it is a shifting landscape, but there is no doubt that technology innovations are key to all our customers globally and we're well positioned as a company.
Thank you.
Great, that concludes our questioning.
Speaker Change: Sorry, that concludes our question and answer session for today. I'd like to turn the call back to Harry Blount for any closing comments.
Harry Blount: Thank you, operator. And thank you for joining us today on the call. Have a great day.
This concludes our conference call. You may now disconnect.