Keysight Technologies, Inc. (KEYS) Earnings Call Transcript

I'd like to welcome everyone to the fireside chat with the Keysight Technologies management team this afternoon. My name is John Pitzer. I cover the semi, semi-cap equipment space at Credit Suisse. It is my distinct pleasure to welcome on stage with me Neil Dougherty, the Senior VP and CFO of Keysight. And then Satish Dhanasekaran, the Senior VP and COO of Keysight. It's great to have Satish here and Neil here. We're going to get a little bit of business, a little bit of finance. The format is pretty simple. We've got about 30 minutes in this room to conduct a fireside chat. I'm going to kick things off, but there is a mic in the middle of the room. We're not passing it around this year per COVID protocol. But if you do have a question, just stand up, come to the mic, and I'll make sure they get asked. With that, gentlemen, thank you both for joining us today. It's great to actually do this in person.

I agree.

It's been a while since we've been able to be face to face. Neil and Satish, my first question is usually a fairly open-ended question, especially if there are any new investors in the room, to give you guys sort of the opportunity to talk about the core IP that Keysight brings to the table, the mission statement, the end markets you try to exploit that IP into. Can you help us kind of sort of position the value proposition that Keysight represents for the investment community?

Maybe I'll get started and Neil can add. The mission of the company is to accelerate innovation to connect and secure the world. And towards that end, we service a broad array of applications aimed at the electrical engineer, the software engineer increasingly across different end markets, whether it's communications or aerospace and defense or broad industrial applications. And the contributions that we have made has evolved from just providing tools for every article engineer, which we have done for decades successfully to moving into solution spaces in -- against faster-moving megatrends that are out there, such as 5G or quantum and increasingly with 6G coming in or the semiconductor evolutions, whether it is the 14-nanometer to 7 to 3 to 2 now. There is multiple end markets, including automotive, which was not addressable for us. It's now becoming addressable, moving our way with EV and AV. So this whole electronics revolution is still largely in front of us in Keysight through the transformations and spin of taking on more software-centric solutions as its portfolio value proposition is well positioned to capitalize for the future.

Yes. I don't have a lot to add. I just think, as you know, we spun out of Agilent in 2014. And since that time, have really been working on transforming the company. And over the 7-year window that we've been an independent public company, we've grown the business at a 10% compounded annual growth rate. We've driven about 800 basis points of gross margin improvement, about 1,000 basis points of operating margin improvement and continue to make great progress financially, building a software revenue base, building a base of recurring revenue. So I think there's a lot of characteristics that are indicative of how much value we are bringing to our customers.

No, that makes a lot of sense. And I guess, Satish, probably starting about 150% to 170% go in the stock. There's sort of been this fear in the investment community that you're well levered to the early parts of 5G but not as well levered to the deployment of 5G. And that's been a constant concern on the stock as it's moved significantly higher. And you talked about this a little bit in your opening comments about moving from sort of an in-lab tool to a more of a solutions type approach. Help us understand when you think about the 4G market for Keysight versus the 5G market for Keysight. Could you walk through what specifically you've done to just broaden the served addressable market?

No, this is a great question. I would say, first and foremost, like we're more than 5G. We're taking on a number of the big megatrends that are out there in our end markets, whether it is -- start with 5G in the wireless space, with wireline, with 400 gig and 800 gig in Terabit Ethernet because the communication systems are getting fundamentally redesigned for the future to make a more efficient, more secure and lower cost to operate. And we're playing in a number of these technology evolutions that enable that in the communications industry. In aerospace and defense, there's a technology refresh or modernization that's upon us and with new ways to secure communications, we're well positioned to capitalize on that. And across the industrial customer base, right, there's a lot of electronification, if you will, with IoT and sensors proliferating and in automotive, where there is a revolution happening where -- which is -- where we are well positioned. So across our end markets, our exposure to multiple mega trends gives us that diversification of applications and therefore makes our revenue stream more durable. But to the investors that are looking at Keysight from a 5G lens, I would say that 5G offers a long-term value creation potential for us, one, we recognized early, we invested early in. And we're focused on enabling these continuous streams of innovation that are happening in 5G with Release 15 and now with Release 16. And with Release 17 and 18 that are being defined, we see a really good road map in our R&D base. Congruent with that, we recognized early that the physical layer tools are critical, but there's a value progression happening in the industry from physical to protocol, and we enable the industry by the acquisitions we made and by being first to market essentially in the protocol space. And now we're pivoting again into the application arena, where we see a number of end markets embracing 5G, and this is still at the very early innings for us. As 5G gets deployed at scale, we'll continue to expect that defense and communication needs will embrace 5G. Automotive will embrace 5G and health care and other markets will leverage new use cases that are enabled by the faster pipes that 5G will provide. So we're still in a very good position, but in a very early innings of recognizing the full potential of this technology.

Well, Neil can add onto that, is there any way to help us quantify kind of the area under the curve of the 4G ramp versus the 5G ramp, i.e., how long did 4G last before it peaked? Once it peaked, how long did it remain a meaningful part of the business? And if you think about 5G and what you've done both on the solutions side, on the hardware side, but more importantly, what you're doing on the software layers, how much bigger is that market going to be 4G to 5G?

When you think about the mix, and Neil can add to this as well, when you look at the mix of our portfolio in 4G, it was weighted a bit more on the manufacturing side. And therefore, when you looked at the potential of that technology for us, it would play out over a 4- to 5-year period with a peaking in '12 or '13-ish time frame, 2012 or 13-ish time frame, a few years after deployment. With 5G, what we have done is broaden the scope of the applications we participate in. And we're engaging in more software-centric opportunities, especially in the R&D lab, which tends to be stickier and much more secular. And what we're seeing is there's a continuous stream of complexity our customers are trying to solve. And the value proposition here is all about time to market. And this is critical for our customers. It's not a discussion of cost. It's really a question of how much time can they save by working with Keysight. And so we believe we are well positioned. And if you look at it from a time horizon perspective, we see short-term catalysts with C-band that's playing out right now in the United States as the U.S. operators are deploying 5G in the low frequency bands. We see medium-term catalysts with millimeter wave. And longer term, we see on the horizon, new applications such as O-RAN that are very promising. And this road map will continue to elongate the revenue exposure for the company from 5G.

Yes. The only thing I would add, we've long said that we believe that the opportunity -- the area under the curve to your usual language was significantly larger in 5G than we saw in 4G, not just for the market, but especially for Keysight because of the way we've evolved our portfolio to include those protocol solutions. And I think that's exactly the way it's playing out. And one of the other reasons for that is the complexity, right? We're talking about standalone and non-standalone version, sub-6 gigahertz and millimeter wave versions. And individual service providers in countries going to likely deploy multiple flavors over time. And given its Keysight's, as Satish said, given that our focus is migrated from the manufacturing line to the R&D lab. And keep in mind, Keysight's overall mix is just north of 60% R&D, but our 5G portfolio is even more heavily skewed towards R&D than that. That the -- again, as Satish said, as we move from [ Rel 15 to Rel 16, now Rel 17 and 18 ] coming and things like O-RAN and millimeter wave, which still largely lie ahead for us, this opportunity is lengthening and getting bigger. And again, as we look forward over the horizon, we see ample opportunity for us to continue to drive very strong 5G revenues.

And Satish, I think you and I have talked about this on some of the callbacks. If you look at the 5G network today, it's still mostly a backbone for mobile phones. And you've alluded to this a little bit in some of your conversation about complexity evolving over time. What happens as the 5G network begins to morph into a backbone for all these other applications that makes 5G more interesting, whether that's Industry 4.0, whether it's autonomous driving, whether it's smart cities. Is there another layer of complexity that elongates this cycle for you?

Yes. I think in short, the answer is yes. As we've talked about the first deployments have largely been the non-stand-alone version of 5G, which relies on 4G as a backhaul, largely aimed at getting the smartphone use case enabled. And what we're seeing now is as more operators who first installed the non-stand-alone are shifting into transforming the core networks with the stand-alone version of 5G, which enables them to realize the latency advantages of true 5G network. And I think that -- the power of that is very transformational for mobile network operators to -- their business models to move from just providing smartphone capabilities to addressing other opportunities associated with the networks. And for us, walking our customers through that transition is something we've worked very hard on. We have created a platform that extends and scales as their requirements -- as their technology requirements move -- progress and we're well positioned to enable that transition. But equally important is the other verticals and other verticals that intercept 5G, and that's very exciting, that results in expanding -- expansion of the ecosystem with new end markets now tapping into it, like USDOD has announced a program to have 5G on the bases and all of the secure communications. That's a new application area for us. We're really excited about. We just announced an acquisition of SCALABLE Networks this quarter, again, to enable us to make a contribution into a very new end market, which is -- which would -- as that end market embraces 5G. Automotive and the autonomous car revolution is going to play out over the next decade. And it is really going to rely on a backbone of a 5G network, but customized for automotive. and that's we call it the C-V2X stack. And again, this is an area where we announced a collaboration with NIO in China. You've probably seen that, and this is an area we're getting that spun up and started. But given the architecture of our 5G platform allows us to extend it into the application arena, congruent with the strategy we've laid out, and we feel like there's a long-term potential for full monetization still in front of us.

And Neil, maybe to put you on the spot a little bit. If you think about the volume build out of 5G and then the complexity and evolutions that Satish is talking about, what's the peak year of revenue for 5G at Keysight?

Yes. I mean, I think it's impossible to call at this point. But I think as Satish said, as we look out over the next couple of years, and we see not only the continuing evolution of the standard from 17 to 18, the ongoing development work that's happening in millimeter wave, the introduction of O-RAN, some of the things that we have going on with the recent announcement of the partnership with Google, previously with Amazon. That for the period of time for which we have visibility, we see a robust set of growth opportunities in way for Keysight to continue to increase our contribution to the market.

And then Satish, you rightfully pointed out earlier that it's not just about 5G within your Communication Solutions Group. There's a whole wireline side of the equation. Help us understand how big that part of the revenue stream is inside of CSG today? And when you think about 400 gig moving to 800 gig, how big is that market opportunity over time?

Yes. I think it's -- when we think about our comps business, especially on the commercial side, we really think about the end-to-end communication systems and say, how can we really enable this transformation that's occurring. It starts on the wireless side, obviously, when we have a handset that connects to a base station and you've seen what we have done in 5G. But equally important is the back end of the network, which is wireline but also important is the compute infrastructure that goes with the wireline. So the 400 gig, 800 gig, it's again about the wireline pipe that has to be raved up because of these faster links that have to happen. But think of all the data center infrastructure that's moving into the cloud and the compute infrastructure that's moving closer to the customer, also known as the edge computing, a big change that's occurring, which will continue to play out over the next decade and we see multiple waves of technologies that are being revised if it's the 400, 800 gig to terabit is one wave, the PCI Gen 4 to Gen 5 to Gen 6. DDR4 to DDR5. And I could just come up with many, many more acronyms, but we're playing in all of these technology waves by participating in the standards, working with lead customers to enable them. What that has done for us is really diversify the application suite that we play in so that in any given phase, you might see 400-gig will have an uptick here, but it really provides us a stable secular base of growth for the company over time. And all of these opportunities have inherent software mix, which is also on a weighted average basis, positive to our gross margins. And so when you look at the mix, we maintain a very good diversification between wireless and wireline. You could think of it as half and half of our comms business, and we'll continue to maintain that diversification over time.

And Satish, you mentioned software. And so Neil, I'm going to throw this one to you. It's been a great part of the story as it's grown as a percent of revenue. Kind of how do we think about the trajectory from here on the software business and the recurring revenue business.