KEYS
#We talked about a $25-million cost reduction program that was announced at the end of Q2 last year, and we said that was a two-year program, and we are materially ---+ it's not totally complete, but we are well on our way to having fully realized that $25 million worth of savings.
And then there was another $20 million of cost-related synergies that come out from Anite, and it was those synergies that are pretty heavily back-end loaded.
So we're very much on track with Anite to deliver those synergies, but given some of the work that had to be done, that was going to be back-end loaded.
So that was a $20-million run rate at the two-year anniversary of the Anite acquisition.
Both are on track.
Well, we cannot make any specific comments with regards to M&A.
The one big question that was asked before was gee, Keysight is a good operator, as you have seen what we have done in Agilent.
And the question was can we also do that effectively with M&A on inorganic activities.
I think we've shown that we can integrate companies very, very effectively.
We could retain the key management people, and we could generate orders and accretion.
Of course, we would not do an acquisition if we couldn't get to at least 15% return on invested capital.
I think this is another proof point, beside some of the smaller proof points that we don't talk about, that shows that we can be very effective at creating value through organic or inorganic activities.
Yes, <UNK>, this is <UNK> <UNK>; I will take that.
Overall, the communications ecosystem is soft.
If we look at it from a manufacturing capacity standpoint, I think there's plenty of capacity there for devices.
The same thing is true, a lot of digestion that had to happen in the supply chain, and then certainly we've ---+ virtually every week, every month you see more consolidation and restructuring, particularly in the chipset area.
So those are the factors that are keeping it on the soft side.
Really on more of a positive note, I have seen a very disciplined capital allocation model coming from most companies, where a lot lower emphasis is being put, you might call it a muted investment in 4G and LTE, and more emphasis and increased investment in 5G, as well as high-performance wireless LAN wireless technologies.
The back end of the ecosystem is very strong and healthy data centers, optical network connections.
Other things, so just R&D is strong across the board, good strength in China, and we've great partnerships with key players all around the world throughout the entire ecosystem.
And that's leading to a lot of very strategic design wins for us.
I would just add that if you look at where we are now versus where we were at this time it in the 4G cycle, we are much better positioned than we were before.
We are much more focused at working to bring the right solutions to market.
We're confident in our progress, and our operating model is intact and we know how to turn that into cash.
<UNK>, this is <UNK> again.
We're really still in the early days.
This is prestandard phase of 5G.
Most of the engagements are very strategic, working with customers, trying to understand their most challenging problems associated with the new millimeter-wave frequency.
So it's going to be ---+ we really thought 5G was going to hit mainstream in 2019, 2020.
We've definitely seen that accelerate.
I think it could start to become more significant for us in maybe 2018.
But between now and then, it's more about strategic wins and alignment with key customers, so you're viewed as a solution provider of choice.
On the one hand, you're correct; the warranty doesn't reverse, but it was a one-time entry to adjust the overall size of our warranty accrual, which is now lower because of our improving quality of our instruments.
So just generally speaking, our warranty costs are less than expected.
And so you will see a benefit going forward, but there was a one-time benefit in Q3 to adjust the size of the warranty liability.
Going forward, as we look forward to next quarter, so the sequential deterioration is really due to that.
We believe our gross margin performance continues to be very strong.
We continued to see a larger and larger portion of our revenue come from R&D solutions and from software solutions, which tend to have higher gross margin.
So we're very pleased with the trajectory of gross margins within the business.
The core communications orders were flat for the quarter, and I'll let <UNK> talk a little bit about the trends.
Revenue was flat within communications for the quarter, not orders.
I think we've covered a lot of the trends.
We have talked about the overall market remaining soft.
I highlighted a few areas of supply chain issues, consolidation, restructuring.
I think the big strength we're seeing is in the R&D phase.
It's all about new technologies, very selective investments by customers in various 5G technologies, high-performance wireless LAN technologies, data center technologies, optical technologies.
So, those are the areas where we are seeing strength.
There is big investment in the China chipset companies, and we've got partnerships with a lot of those companies that ended up playing into the communications ecosystem, as well.
You asked ---+ the second part of your question was about semi conductor, and I think we're really seeing strength in a couple of areas there.
First of all, there's a broad effort within China to go after the semi-conductor markets spaces, big investments that are happening in China that are driving strength in our parametric test business and across some of our other solutions that fill into semi conductor, as well.
And then just generally speaking, across the foundries, there is a migration to smaller and smaller chip architectures.
As they migrate to those chip architectures, they can drive demand for our products, as well.
We have sized our software business.
About a year ago it was north of $300 million prior to the acquisition of Anite, and Anite added an additional $100 million to our software business.
So that gives you an idea of the portion of our business that is coming from software.
The only thing we've said publicly about the proportion of our manufacturing versus R&D business is that we have jumped the threshold where R&D is now the larger portion of our business, greater than 50% and we did that a little over a year ago, as well.
It continued to make progress in that area, so that it doesn't move terribly quickly but we continue to migrate more and more toward software solutions.
I would also note that the Anite business, which we acquired a year ago this week actually, was almost exclusively sold into R&D-type application.
So that helped to drive that balance, as well.
And Charles, our overall strategy is really played out in the numbers <UNK> was just talking about.
Our overall strategy is to move from hardware-centric products to software-centric solutions.
So in doing that, we're seeing the percentage of our software business.
We'll be driving that up further and further.
Second, we'll be moving to more solutions, which includes not only software, but includes a lot of services from John Page's groups.
But on top of that we are migrating and migrating as quickly as we can from manufacturing to R&D.
That is something that we stated back as early as 2013, and we have made great progress on that where R&D is our number one market, as <UNK> had pointed out.
This is <UNK>.
Definitely we have had one of our successes with Anite, the leverage of the sales channel that we have in Keysight and driving some of the key products into broader customer sets.
Aerospace defense is one, but it's more generic than this.
Anite came with a nice portfolio of solutions.
One is the channel emulation solution where they are leading, in fact, and we have been able to start purporting this to a number of customers as we go.
And clearly it has helped.
But more work is happening and I'm pretty bullish for this type of technology going forward.
Let me address some of those questions.
First of all, with regard to the back half of calendar year 2016 and beyond, obviously, we only provide guidance one quarter out, and so you can see what we provided there.
If you take a look at the mid-point of our guidance, that implies about a 3% decline in our total business for the year, which we actually think is better than what the total market is achieving.
We think the total market this year was down mid-single digits.
As we look forward, we talked about the softness we're seeing in communications and what we're seeing in Europe.
With regard to aerospace defense, we're relatively ---+ we expect to see normal cyclicality with regard to the aerospace defense business in the US, which tends to peak around government fiscal year end in September.
We have seen some softness in our offshore aerospace defense clients.
I think over the longer term, I'd point back to the next-generation technologies where we are seeing continued and rapid growth.
We believe we're well-positioned to win in those markets, and those are the markets that are going to drive overall growth in the business when the broader market recovers.
So we believe we're well-positioned and we have an operating model that enables us to deliver strong profitability in a variety of economic conditions that's evidenced by the 20% operating margins that we developed this quarter.
I think our Op Ex trends are more or less in line.
We basically have been maintaining our R&D investment on a dollars basis.
You can see, as our top line has been moving around, our R&D investments have been pretty stable, and that's intent with us maintaining our investments for the future, and basically not over-reacting to short-term perturbations in our market but making sure that we're making the investments that we need to make to stride growth in the future.
And similarly on the SG&A lines, I think you shouldn't expect any material change here.
Hi <UNK>.
You were very astute; that's exactly what we saw.
If you look at our forecast, and we do a monthly forecast, actually we do a roll up every couple of weeks.
But if you take a look at the forecast month by month for the sales organization, we were on the first month of the quarter on the second month of the quarter and off by $20 million in July.
So that really adds up to what we're seeing.
It's not all Brexit.
We see Russia and Russia being weak in aerospace defense and a general malaise in Europe.
And as I did point out earlier, every region grew in orders with the exception of Europe.
We feel very good about our business and our competitive position, but we do deal with the economic situations that do exist around the world.
But this will not stop us from investing and making sure that we're leading for the next wave of 5G.
I'm going to ask <UNK> to see if he wants to make any other comments about Europe.
On Europe, I think <UNK> did most of the summary.
Clearly it has ---+ we have seen the impact in July, and this came after the announcement of Brexit, but also Russia was weaker.
Across the board in the rest of the world, we must say that we grew all this in all the other regions, and clearly, America was stable or at steady aerospace defense from prime contractors on major programs that we're winning, so America is stable.
Japan was steady with broad industries good successes, and then Asia was strong.
We had very solid growth of our business in China, for instance, on the semiconductor solutions that <UNK> mentioned earlier, but also optical and 5G.
So that's a broader perspective of what's happened, and I believe we are very well-positioned in the market with our solutions, especially for our next-generation technologies.
We don't comment on markets further out, but I just will make a couple of qualitative comments.
Obviously, you remember everything in 2009, and then we saw a big bounce back of over 20% growth in 2010 and 2011.
And we're not in that situation at all.
We do see at times in R&D where there is a pent-up demand where business is soft and people are holding off on the capital equipment, and capital equipment can pop back a bit.
But we do not forecast that further out.
But as you know, our markets are cyclical and we have seen them come back at times.
I do think on the manufacturing side that the actual cost per test has reduced, as we have all talked about for manufacturing smartphones.
We saw that in 2011 ---+ 2012.
We walked away from a major supplier at that point, and it turned out to be a pretty smart move that was a very profitable deal for us.
And I think in the future it would have been slightly different.
But as far as when the market will bounce back, we do not predict that.
<UNK>, are there any other comments that you'd like to add.
Yes, I would just point you back to some of the numbers that we've put out there, right, that we think the market in 2016 is down mid-single digits.
We don't ---+ we're not going to call and uptick until we see it.
That being said, as we look forward, where we see the softness in coms, the softness in Europe.
We're incorporating that into our market outlook, but it's hard to know when things are going to turn around.
We've built a business model that is designed to deliver strong profitability, whether ---+ recognizing that our markets move in a plus to minus 10% band.
And you see that in the profitability that we're generating today.
And looking over the long term, we do see pockets of the market focused around next-generation technologies that are growing very well.
5G, the new semiconductor processes,100-gigabit, looking forward to 400 gigabit.
And we really like the way we are positioned in those next-generation technologies.
So when markets recover, again, we like the hand we have and we like where we're positioned.
The warranty benefit was spread across the other businesses, all businesses, and no one business disproportionately benefited from that.
I think you're seeing basically the favorable mix of products that was sold in that business on a business that had a pretty strong revenue performance for the quarter, as well.
If you look at historical financials for that business, which are available on the website, you'll see there is some volatility around profits, but there been several quarters over the past couple of years where the profits have ticked up to this kind of level, driven by top-line, driven by mix.
<UNK>, I'd just like to make one last comment.
You can see our operating margin of 20% at this revenue level.
I think we have done a pretty decent job of managing to a solid operating model.
And if the revenue goes up, our incrementals look pretty darn good.
And as we've commented that they're 40% when our growth rate is above 40%.
4%.
Thank you, Christine, and thank you all for joining us today.
We look forward to seeing many of you at the upcoming investor conferences that I mentioned at the top of the call, and I wish you all a good day.
Thank you.
