Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Third Quarter 2020 Earnings Conference Call. My name is Chris, and I'll be your lead operator today. Please note that this call is being recorded today, Wednesday, August 20, 2020, at 1:30 Pacific Time. I would now like to turn the conference over to Jason Kary, Vice President, Treasurer and Investor Relations. Please go ahead, Mr. Kary.

Thank you, and welcome, everyone, to Keysight's Third Quarter Earnings Conference Call for Fiscal Year 2020. Joining me are Ron Nersesian, Keysight's Chairman, President and CEO; and Neil Dougherty, Keysight's Senior Vice President and CFO. Joining us in the Q&A session will be Mark Wallace, Senior Vice President of Worldwide Sales; and Satish Dhanasekaran, President of the Communications Solutions Group. You can find the press release and information to supplement today's discussion on our website at investor.keysight.com. While there, please click on the link for quarterly reports under the Financial Information tab. There you'll find an investor presentation along with Keysight's segment results. Following this conference call, we will post a copy of the prepared remarks to the website. Today's comments by Ron and Neil will refer to non-GAAP financial measures. We will also make references to core growth, which excludes the impact of currency movements and acquisitions or divestitures completed within the last 12 months. You will find the most directly comparable GAAP financial metrics and reconciliations on our website. We will make forward-looking statements about the financial performance of the company on today's call. These statements are subject to risks and uncertainties and are only valid as of today. The company assumes no obligation to update them. Please review the company's recent SEC filings for a more complete picture of our risks and other factors. Lastly, I would note that the management team is scheduled to participate in upcoming virtual investor conferences in September, hosted by Jefferies, Citibank and Deutsche Bank. And now I will turn the call over to Ron.

Thank you, Jason, and thank you all for joining us. Keysight delivered stronger-than-expected third quarter results, demonstrating the exceptional resilience of our business for the second quarter in a row despite ongoing macro challenges. I am proud of how the Keysight team rapidly adapted to a new operating environment while delivering on our commitments to our customers, partners, and shareholders. Today, I'll focus my formal comments on three key headlines for the quarter. First, we delivered stronger-than-expected third quarter results with solid gross margin and record operating margin. Our differentiated solutions drove steady demand through the quarter, and our operational execution was exceptional as we ramped production capacity to nearly 100% by quarter end. Second, despite the ongoing pandemic uncertainty, we remain confident in our differentiated leadership position and the long-term secular growth trends driving our markets. The past two quarters have demonstrated the resilience of the Keysight leadership model, which we believe provides a durable competitive advantage for the long term. And third, despite near-term macro disruption, we expect to achieve year-over-year revenue and earnings growth in the fourth quarter. Now let's take a deeper look into our financial results and the market dynamics within the quarter. Despite the challenging macro-environment, demand for Keysight's differentiated solutions was steady through the quarter. Orders declined 4% year-over-year and 2% sequentially, in line with our typical Q2 to Q3 seasonality. Revenue declined 7% year-over-year while increasing 13% sequentially. The durability of our financial operating model and the flexibility of our cost structure was exceptional as we delivered third quarter gross margin of 64% and record operating margin of 26% and free cash flow of $151 million. In commercial communications, we continue to see the global adoption of Keysight's 5G platform. Our end-to-end solutions for the 5G life cycle across both wired and wireless domain and from R&D and high-value manufacturing are enabling the ecosystem to scale from product development to deployments. 5G commercialization is progressing and on track to add an estimated 190 million subscribers in 2020. Device design and development investments continue to be strong, driven by the large-scale ramps in Asia. As 5G deployment expands and ongoing innovations gain customer interest, we continue to see strength in R&D. With several test house announcements this quarter, Keysight's leadership is further solidified as our 5G test platforms are now being used by all the leading test houses worldwide. Keysight's first-to-market 5G design and test solutions are also helping to accelerate and enable the virtualization of the radio access network and the rapid adoption of the open radio access network technologies. We also saw strong demand for our high-speed digital and optical solutions driven by 400G manufacturing expansion and an uptick in R&D investments in 800G. Keysight is well positioned to capitalize on commercial rollouts and mainstream deployments. Our comprehensive platform provides end-to-end solutions that enable customer innovation throughout the entire 5G life cycle. In aerospace, defense, and government, orders were strong in the U.S., offset by lower investment in Europe and, to a lesser extent, in Asia. We continue to see strong demand for our electromagnetic spectrum threat simulation platform as well as solutions for radar, space, satellite, and 5G. In addition, we continue to enable our customers' initiatives to increase their electronic supply chain capacity and reliability in the U.S., which we believe will be a multiyear opportunity. In the automotive sector, macro-driven weakness persists. However, the fundamental drivers for long-term investment in electric and autonomous vehicle technologies continue to be a strategic industry priority. As the industry adapts to tremendous change in multiple technology disruptions, Keysight is investing in first-to-market solutions and remains firmly engaged with key market players. We recently announced a multiyear collaboration with IPG Automotive and Nordsys to jointly develop a new modular test platform for autonomous drive emulation. This will accelerate the validation of advanced driver-assisted systems and functions for autonomous driving. Strategic investment in next-generation semiconductor process technology remains a priority for our customers. Demand is being driven by 5G smartphone processors, high-speed networking, and high-performance data center applications to serve the work-from-home economy. This trend resulted in double-digit year-over-year order growth for semiconductor measurement solutions. Software and services, again, delivered solid revenue growth this quarter. Our software-centric solutions strategy is providing strong value to our customers. Services and support, such as KeysightCare, continue to expand to higher value-added consulting and optimization offerings. At greater than 30% of total revenue, our growing mix of software and services is contributing to the durability of our business model while increasing recurring revenue and improving gross margins. With the bulk of our 5G opportunity ahead of us and millimeter-wave commercialization still in its early days, we recently launched a PathWave design 2021 software suite. This advanced software accelerates 5G design, simulation, and verification workflows with an integrated solution that ensures design performance, improves accuracy, and speeds time to market. In the manufacturing arena, Keysight continues to collaborate with leading 5G infrastructure customers, a new cloud-based PathWave manufacturing solutions. We continue to increase our solution differentiation with strategic acquisitions, expanding into the application layer in growing our addressable market. We recently acquired Eggplant, an industry-leading software test automation platform provider. Eggplant's differentiated technology uses artificial intelligence and analytics to automate test creation and test execution. With this acquisition, Keysight is now the only company that can provide test capability from the physical layer through the application layer and extending to the user experience, or UX. Eggplant's customers span a wide range of sectors overlapping Keysight's existing customer base while expanding software test opportunities into new end markets. Looking back at the past two quarters, our performance exemplifies the core values of the Keysight Leadership Model on multiple fronts. We demonstrated operational excellence and the durability of our financial operating model. KLM also expands beyond financial accountability and aligns with our foundational pillars of corporate social responsibility. We released our latest annual CSR report in May. We are proud to have surpassed our social impact goals in community and education while making progress on our governance and environmental goals, including climate change. Lastly, as a result of recent events, we are taking further actions to expand our inclusion and diversity programs to advance racial equality. For example, we are working with academic institutions, including historically black colleges and universities to reinforce our diversity recruiting strategy. We are committed to accelerating racial equality and will do our part to make a difference. To wrap up my comments, Keysight's execution this quarter is a reflection of our values and our commitment to customers to deliver first-to-market solutions for their businesses and technology challenges. I couldn't be prouder of the Keysight team. They have risen to the occasion in a challenging environment and continue to execute on customer commitments while at the same time upholding the values that make Keysight a diverse, inclusive work environment with the culture of innovation, ownership, passion, and respect. Now, I will turn it over to Neil to discuss our financial performance and outlook in more detail.

Thank you, Ron, and hello, everyone. Note that all comparisons are on a year-over-year basis unless specifically noted otherwise. Keysight delivered a solid quarter, thanks to steady demand and strong execution. Despite a challenging economic environment and supply chain disruption, our financial and operational performance demonstrated the durability of our operating model as reported record operating margin and solid cash flow. This performance also proved for the second quarter in a row, the effectiveness of our financial playbook, which is designed to preserve margins and cash generation during challenging times. For the third quarter of 2020, we delivered revenue of $1.011 billion, down 7% on a reported and core basis. Our team executed well in ramping production capacity and managing supply chain constraints, which resulted in stronger-than-expected sequential revenue growth of 13%. Orders of $1.067 billion were down 4% on a reported and core basis and were steady through the quarter in aggregate. Regionally, demand accelerated in Asia and began to stabilize in the U.S., while Europe lagged as the pandemic continues to hamper their economic recovery. Turning to our operational results for Q3. We reported gross margin of 64% with improved mix and lower discretionary spending, offsetting the impact of lower revenue. Expenses were well managed as we benefited from our flexible cost structure and the specific actions that we initiated last quarter. The combination of strong gross margin performance and expense discipline resulted in record operating margin of 26%. Net income in the third quarter was $226 million. On a per-share basis, we delivered $1.19 in earnings on a weighted average share count for the quarter of 190 million shares. Regarding the performance of our segments, we saw continued strength in 5G investments, both in R&D and in manufacturing as well as next-generation semiconductor node technologies, which drove double-digit order growth across both markets, respectively. This strength was offset by weaker spending in legacy communications, automotive, general electronics and international aerospace defense and government markets. Exceptional execution and expense discipline resulted in CSG operating margin of 26% and EISG operating margin of 27%. Moving to the balance sheet and cash flow. We ended our third quarter with $1.7 billion in cash and cash equivalents, with $450 million of additional liquidity available under our undrawn revolving credit facility. Our quarter-end cash balance reflects the impact of the $319 million net of cash acquisition of Eggplant. We reported cash flow from operations of $183 million and free cash flow of $151 million. We did not repurchase any shares during the quarter. Turning to our outlook and guidance. As Ron mentioned, we expect to make continued progress in Q4. And as a result, we expect fourth quarter revenue to be in the range of $1.170 billion to $1.190 billion and Q4 earnings per share to be in the range of $1.42 to $1.48 based on a weighted average share count of 190 million shares. At the midpoint, this represents 5% year-over-year revenue growth and 9% year-over-year earnings growth. These expectations assume limited incremental supply chain constraints or disruption from additional shutdowns or a second wave of the pandemic. While the near term remains challenging, the long-term secular growth trends in our markets remain intact. We continue to invest in R&D and focus on our long-term strategy of enabling customer success through first-to-market leading-edge solutions. As I mentioned last quarter, the durability of our business model, steady cash generation, strong balance sheet and market leadership give us confidence in our long-term core revenue growth target of 4% to 6% and operating margin target of 26% to 27%. With that, I will now turn it back to Jason for the Q&A.

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

The first question comes from Samik Chatterjee with JPMorgan.

If I can just start off with asking for a bit more color about the order trends. Orders did moderate slightly on a sequential basis, and I know you have referred to it as largely seasonal, but maybe if you can share some insights on what you're seeing in terms of order trends outside of the normal seasonality? For example, in commercial communication, how would the order trends for the quarter? And in the markets, end markets that are weak, for example, automotive, what are the magnitude of kind of declines or changes in order trends you're seeing there? And I have a follow-up.

Samik, this is Ron. I'm going to ask Mark Wallace, the Head of Sales, to talk about the order trends first. And then I think Satish can also add some more color commentary towards your commercial communications questions.

Okay. Thanks, Ron. Samik, thanks for your question. So orders were very steady throughout the quarter. And actually, in certain areas, they trended to increase as we saw some of the COVID-related impact diminish. But we've seen continued investment in next-generation technologies with strong order growth in 5G. That's already been mentioned. Our high-speed digital and optical solutions to support our 400-gigabit data center expansion, customers around the world has been very strong. And the advanced semiconductor process technologies, including EUV, which is extreme ultraviolet, 5-nanometer continue to be very strong. And with semiconductor, in particular, we saw strength across all of the regions. So the other part that was up was aerospace defense for us in the U.S., and that was offset by some weakness in Europe, principally due to the COVID effects and some mix conditions in Asia. The COVID impact, I would say, there was some disruption certainly across all regions, but Asia was least affected because they came out first. And on a relative basis, we saw a larger impact across Continental Europe, where many of the countries and economies started slowly restarting and reopening in late May and June. So where do we see this impact? We saw it in general electronics, some of our indirect channels and in areas where government funding was redirected like in education and in research. And then the macro impact from automotive remains soft. But as Ron noted, EV and AV continues to be a very strong top priority for our customers for the industry, and we had several large new customer wins in the quarter. So what I would summarize this as, overall, there were COVID-19 headwinds, but our sales productivity and customer engagement remained very high. We delivered steady and improving orders throughout the quarter. Much of that was delivered by growth and demand from our solutions for 5G, 400-gig, next-generation semi. And we also delivered strong growth for services as customers relied on us to help support their operations and the adoption of KeysightCare continues to grow. And we built a strong funnel along the way as well. So Satish, I'll hand it back to you and you can make some further comments on commercial costs.

Yes. I think, Mark, you covered it. I'll just maybe say that the strength in our 5G was broad, and we continue to see strong demand for our offerings.

Okay. If I can just follow up on the question on margins and maybe this is more for Neil. But Neil, in calculating the implied operating margin of somewhere close to 27% in the fourth quarter based on your guidance, when I look at it on a sequential basis, I think it's implying more of a 33% incremental margin. So I just wanted to check on that. It does sound a bit low. Particularly, it does imply your ramp up on the OpEx level that I wanted to check if that's really realistic given some of the changes you might have made in the cost structure as well as some of the temporary cost reductions you're benefiting from.

Yes. We usually notice some uptick in expenses when transitioning from Q3 to Q4, particularly as we approach the end of the year and strive to finish strongly. The 40% incremental is not meant to apply consistently from quarter to quarter; there will be times we exceed it and times we fall short. However, we are committed to achieving that 40% incremental over the medium to long term, which we have managed to do. Overall, I believe we are well positioned in this regard.

And our next question is from Brandon Couillard with Jefferies.

Maybe Ron or Neil, could you just elaborate on what you saw in China in the quarter in terms of core orders and revenues? And remind us what the total impact of the trade restrictions were in the third quarter, was that about 3% or 4% in total?

Brandon, this is Ron. I'm going to pass this over to Mark, who manages, obviously, China sales, but I think he also can make some comments with regards to Huawei because new news came out this week.

Yes. Thanks, Ron. So, business in China during Q3 was strong. We saw order growth and revenue growth. And much like my comments earlier, we saw a steady flow of business throughout the quarter. Again, strength in 5G with some of the market leaders as well as increasingly selling to this longer tail of customers within the ecosystem, this is where we saw a lot of growth with high-speed digital and optical manufacturing, again, driven by this global demand from our data centers or the data center customers around the world, and China continued to invest in semiconductor capability. We saw some headwinds from COVID, mainly from other parts of the world as opposed to in China directly, some macroeconomic influence from automotive. We did see an impact in Q3 in aerospace and defense. As you may recall, there were some new regulations that were announced in May that were put into place in late June around military end-user customers. So, we saw a small effect because it was later in the quarter. We are starting to see some rebound in some of the markets that were early affected by COVID, like general electronics starting to show some signs of recovery. But outside the quarter, Ron referenced this earlier this week; there was a new regulation for Huawei and a broader entity list that was published. And this was describing some increased restrictions on the sale of products which are manufactured outside of the U.S. but have U.S.-based technology or software as part of the development. So, this shift to tighter restrictions than the previous regulation will limit sales to Huawei and their affiliates. There were some additional announcements made on some additional affiliates added as well that don't have much of an impact. So I'm going to pass it to Neil to make some more quantitative comments. The one thing I will say, though, is that we faced adversity and challenges in China in the past, and we've been very effective at redirecting our focus and priorities and we're certainly looking at that as we continue to digest the information. So Neil, why don't I pass it to you, you can comment further on the FX.

Yes, I just wanted to give some more specific quantification of the likely impact of this new Huawei news. So we had said previously, based on previous rounds of restrictions to Huawei that we expected Huawei to be a 1% to 2% customer. Year-to-date, they've actually been exceeding that. They're closer to double that rate with increased sales in Q1, which we talked about and then, again, here in the third quarter. As we look forward to next year, it does look like these new restrictions are pretty comprehensive. And so we expect Huawei to be a very small customer for us going forward, but again if you think about it from long term, we were already expecting them to be a 1% to 2% customer. So the headwinds are a little bit bigger next year, potentially up to 4%. But over the long term, it's a pretty minor adjustment from what we've been expecting.

That's very helpful. Just maybe one for Ron on the Eggplant acquisition. It sounds like a pretty interesting asset. Can you sort of speak to the growth rate of the business, some of the primary end markets and the margin profile of the business and whether that acquisition is dilutive to EPS near-term or not?

Sure, Brandon. Eggplant is really an exciting acquisition for us. Again, as we move more and more to software-centric solutions, this fits in right with our strategy. And the way to think about this is a lot of our products or most of our products test hardware or test firmware within our customers' end products. This tests software, so we're finally using software to test software. And in particular, this is used to test user interface development. So when someone's developing a new user interface, how do you know that it's effective and it will be something that can get customers through the interface and have a really good user experience. So it's a special unique set of AI that's existed by anybody that creates any type of user experience on the web. The customer base is broad aerospace defense; it's one area where there is a lot of sales, but it even sells, for instance, into the financial community. It is accretive to us. It's a small acquisition. It is growing and growing at roughly double digits. But it has tremendous potential as we marry that in the future with the rest of Keysight and, in particular, with our PathWave architecture.

Next question is from John Marchetti with Stifel.

I was wondering if we could just come back to China, maybe a little bit more broadly and not just Huawei, in particular. Neil, I know you gave us some of the numbers there about the headwind that you're expected to face. But you mentioned some of the strength you saw in their efforts to be more semiconductor independent and things like that. How much, I guess, is we're looking a little bit more broadly than just Huawei? Do you see this as a potential headwind as we look out maybe over the next several quarters, if we're going to see some broader entity enforcement on this list against U.S. technology?

So John, this is Mark. I will address part of that question. First, China is a very broad and diverse market for us because we serve multiple segments, including semiconductors. According to the new regulations, our semiconductor test solutions are not directly impacted because these parametric test systems are designed and manufactured outside the U.S. However, we are monitoring the potential effects of decreased chip demand from the foundries. We are keeping an eye on the situation and considering future developments. Nonetheless, we anticipate ongoing investments driven by 5G and other key technologies, not just in China but globally, to support next-generation process technologies.

Got it. And then maybe if when we look out over the next quarter or so, how should we think maybe about some of these geographies. You said you saw some improvements, obviously, post-COVID. As that continues maybe to get a little bit better in Europe and, hopefully, here in North America, do you expect some of the easy order strength or some of the momentum come back into that order line? Just sort of getting back to Samik's question about down again on a year-over-year basis, a little bit worse sequentially. Just trying to get a sense for how you're feeling about the overall order trends of the business.

Yes. So if you're referring to semi specifically, there's going to still be market constraints in the coming quarters. The demand will be based somewhat on supply and how much acceleration occurs in the end markets. More broadly, we are seeing improving conditions clearly in North America at the early rebound of some of the businesses that were impacted by COVID in Europe, in particular. We saw the sequential improvement during Q3, particularly in Europe, and we expect to see that continue in those two geographies. Asia is pretty much through that as we stand now. And then you have some seasonal effects with aerospace defense being large in the U.S. in Q4, and we're expecting to see that surge occur, again, as we get to the end of the government's fiscal year.

Next question is from Tim Long with Barclays.

I wanted to ask on the 5G side. Could you talk a little bit about where we are in the transition to the manufacturing side? It sounded like both R&D and manufacturing were strong in the quarter. But could you just touch on kind of where you're starting to see a little bit more traction on the manufacturing side as equipment manufacturers start to ramp up to meet the growing demand? And then secondly, if we could just touch on 400-gig and 800-gig. It sounds pretty positive for the traditional wireline and Ixia businesses. Could you just give us a little color on kind of the complexion of that business? How much is data center? How much is telco? How much is in the China end market? That would be great.

Yes. Thanks. I think, first, I want to say that from a 5G perspective, the industry continues to progress in a very strong manner. There have been some pushouts in some parts of the world, acceleration in others. Net-net, our long-term view and outlook remain unchanged, and we look at it both from deployments and actually the number of devices that are going to be manufactured this year. So pretty strong from that point of view. And we see that strength reflected in increasing demand for our R&D solutions, but also on a year-over-year basis, we had a very strong uptick for our manufacturing solutions. I think I referenced before, our modular offerings, especially are resonating very well with base station manufacturing and components, and our funnel strength in that area continues to be strong as well. With regard to the 400-gig business, this is the third straight quarter where that business has had strong growth. We've had differentiated offerings. You're right in that a lot of the demand so far has been driven by the web-scale companies into data centers, which we think will continue to accelerate, and the industry is not done and awaiting. So there's more innovation on the 800-gig that's underway as well, and a bulk of this opportunity from a production perspective is playing out in Asia, and we're capturing the majority of the share on that front. And we'll continue to see that as the industry progresses to 5G and especially standalone use cases, more of the operator-based or metro-based versions of 400-gig play out. So we feel strong about the overall wireline opportunity as well.

I would just add a comment, too. When you look at oscilloscope, which includes sampling scopes that serve this optical market, the results were very strong with double-digit growth in orders. And when we look at that on a competitive basis, we're very happy with our performance and our relative performance.

Next question is from Mehdi Hosseini with Susquehanna.

My first one has to do with your guide. When I look at the past 3 to 4 years, you have done a great job of keeping book-to-bill above 1.0. And if I were to take the midpoint of your revenue guide, it would suggest that booking would have to be up by double digits on a sequential basis and kind of flattish on a year-over-year basis. And I'm not asking for a guide or a booking, but I'm just wondering if the funnel of business opportunities that you laid out last earnings conference call seems to me that is beginning to materialize, especially with COVID behind us. And is this the right way to think about it? And anything else you can add to it will be great. And then I have a follow-up.

Sure, Mehdi. Yes, obviously, we don't guide orders, as you know, and we haven't commented on orders in general. We have built our backlog up over the past quarters. That's good. And given all the supply constraints and things that come in from external to Keysight's manufacturing, we see that backlog position that we have remaining roughly in the same area with some puts and takes as we go forward. And as far as orders, as far as going in that, we're very pleased where we are. Quarter-by-quarter, we'll see how Q4 happens. We clearly were very pleased with our order performance this last quarter and our book-to-bill based on what's going on in the environment. But I'll leave it at that.

Got it. And I wanted to dive into the networking Ixia. It seems to me that based on the peer group, there is acceleration on R&D for 600 and 800-gig, and perhaps this could minimize the tailwind of 400. And I'm just wondering if you could comment on it just to remind us how you see your networking split between R&D and production.

Yes. I think the way to think about it, Mehdi, is we have a diverse portfolio in commercial communications. And on the wireline side, we have a good breadth for solutions, both between R&D and production, and they sort of feed each other. We start early with customers and follow that lifecycle as they get into production and get back into deployments with operators. So it's that whole, let's say, solution franchise that we have that allows us to maintain a pretty steady business. And on the wireline side, in particular, the business has been a lot more steady and augmented by the addition of the layer two, layer three capabilities from the Ixia acquisition. So yes, right now, data centers are driving 400-gig demand. We expect then the telecom demand to pick up and then simultaneously 800-gig with the first instantiation being 100-gig serial-based will start, and that goes into production. So these waves continue and give us a lot of stability in our commercial communications outlook.

Next question is from Mark Delaney with Goldman Sachs.

First just something to better understand the growth outlook in the EISG segment and understanding that the comments that the company made in prepared remarks about some weakness that has been seen in the industrial and automotive portions of your business. But when I look at the ISM Index back to year-over-year growth, auto production is ramping back up pretty quickly. The company commented about electric and autonomous vehicle investment continuing. I'm wondering when you think some of those factors may translate into better demand indicators for your EISG segment?

Mark, this is Ron. First of all, congratulations on your new role, and thank you for covering Keysight. We're pleased to have you on board. Regarding the automotive sector, we aren't ready to announce a significant upturn yet. While we've observed negative growth rates in the automotive industry, there is a positive trend in the second derivative, indicating that the rate of decline is slowing down. However, we still do not see this translating into increased cash flow for the auto industry that would contribute to R&D funding. Therefore, we intend to proceed cautiously during this period but are prepared to take advantage of any new spending that arises. Much of the investment in autonomous and electric vehicles remains a major strategic priority for us. We have numerous solutions available in the market and others in development. Over the coming years, we see significant opportunities ahead.

And also, thank you for the nice welcome. And for my other question, I do want to understand on EBIT margins, the company did a 26% non-GAAP EBIT margin this quarter, which I believe was the target model for 2023. So coming in well ahead of your plan with respect to profitability margins. Maybe you can talk about how sustainable you think this level of EBIT margin may be, certainly implied to be at the kind of levels again next quarter. But as you think about between now and 2023, you're already at those levels today? Is this something that you think you can sustain? Or can you even potentially operate above your target margins?

Yes. We recently announced long-term target margins of 26% to 27%. As I mentioned earlier, we are very confident in our ability to reach and maintain these levels over time. We've achieved 26% this quarter, but these are unusual times, and we don't anticipate next quarter will be typical either. Our unique operating model allows us to uphold profitability and cash flow generation even during challenging economic periods. A crucial aspect of this model is the variable pay structure for all our employees, which is driven by organic growth and operating margin. Currently, the organic growth situation, influenced by the macroeconomy, is enabling us to save considerable amounts on our largest cost, which is our workforce. We've also noticed significant reductions in spending in other areas due to COVID, such as travel and materials for R&D projects, with engineers working from home. Additionally, we've implemented specific measures regarding temporary workers and discretionary spending. Looking ahead, we remain committed to achieving 26% to 27% margins and are pleased with the short-term results. However, as costs return and we encounter other expenses in 2021, we are closely monitoring our pension expenses, which are expected to rise due to historically low interest rates. This means there may be some short-term challenges, but we are on track for a long-term trend toward sustaining those 26% to 27% operating margins.

Yes. As Neil said, there are a lot of things, puts and takes that we're managing, as he said, everything from pension expenses in this low-interest rate environment. We had temporary executive salary cuts. The overall comp that we had on a variable pay basis, travel, etc. However, it is worthwhile to note from my chair, it's always a balance between long-term profitability and short-term profitability. And as we look at this, as we look at the margins, could we take the margins a little bit higher? Yes. But we're investing to make sure we have a differentiated, competitive advantage versus the competition and can give customer solutions that they want to provide growth. And as we model this all out, we think we're in very good shape to create the most value for the shareholders, balancing investment with short-term return.

The next question is from Jim Suva with Citigroup Investment Research.

I have two questions, and I'll ask them at the same time. So you could kind of answer them in any order you wanted. But regarding the Eggplant acquisition that you just closed, can you talk to us a little bit about the contribution for the revenues that it will be for the quarter outlook you did? I'm trying to look at the organic growth rate. I want to see what's going on there. And does it also impact your order growth rate that you just reported, which I think was down about 4% for this reported quarter? Or is Eggplant not into your orders? Then my second question is, can you help us better understand about the connection between your higher revenues next quarter year-over-year, yet your order rates still being negative year-over-year? Kind of how do you bridge those two fundamental metrics?

Yes. Let me take the first question with regard to Eggplant. As you know, or as we've said, it's a relatively small business. But as we report core growth numbers, relative to as reported, we would expect Eggplant to have about a 1-point impact on our growth rates. It's going to add about a point of growth on either the order or revenue line on a go-forward basis. Obviously, they were only part of Keysight for a portion of the third quarter. But on a go-forward basis, that puts it into an order of magnitude. With regard to Q4 and kind of the revenue being sequentially up, but orders continuing to be down on a year-over-year basis, obviously, we are in a strong backlog position. We've been building capacity over the course of the last three months and are now in a position where we can ship essentially at a level that was on par with where we were before coming into COVID, and so that's driving revenue. As Mark said, the macroeconomy is still highly uncertain. We're seeing areas of relative strength and areas of relative weakness, but the COVID situation is impacting more or less every business in the industry equally, and we remain confident in our competitive position and the strength of our technology and over the long term in the secular growth trends that are driving our end markets.

Next question is from Rick Eastman with Baird.

A tremendous quarter. Just a question around the book-to-bill here in the quarter. Obviously, the math is at 1.05 for Keysight in the quarter. Could you just give us a sense, was the book-to-bill greater than 1 in EISG and A&D?

Yes. Obviously, we're not reporting orders at the segment level. You have the information for Keysight, and we're just not going into that level of granularity.

Okay. Well, let me ask another question. When you look at EISG orders, and potentially, aerospace and defense and you just look at the absolute dollar amount of the orders, is there a general sense that we're stabilizing at this lower level? I mean, we assume the book-to-bill of one. Is there some stabilization in the overall EISG business? And the same question around aerospace defense.

Let me take the EISG portion, and then I'll let Satish address the CSG and specifically the aerospace defense question. EISG, we've talked about the various segments within EISG, and we clearly have an auto industry that is going through some pretty difficult times and our business selling directly into auto was similarly impacted, right? And so you're seeing, I'd say, a more severe macro impact or an above-average negative macro impact in the auto industry. At the flip side, you've got the semi industry, within EISG, which is doing very well right now as folks are investing in process technology; you have 5G and other things that are driving semiconductor demand. And so not just us, but across the semi industry, you're seeing relative strength even in a time of broad macro weakness. And then the third piece being general electronics is the one that's kind of most macro-tied, and we've often talked about that being our most GDP-linked business. And so there, I think you're going to see the performance of our general electronics business largely mirror what happens with the broader economy as we recover from COVID. So Satish, do you want to comment on aerospace defense?

Sure. So obviously, I think you see the revenue line was down for the aerospace and defense business. But when you look at the orders, this was the second highest Q3 in the last five years. So the business is actually holding up very well with strength in the U.S. And our own position with respect to electromagnetic spectrum operations, 5G, and space and satellite is strong. And when you couple that with the prime contractor backlog that has continued to increase through the year, it also sort of portends a strong indicator for future orders as well.

Okay. And then if I could just sneak in one more thing. Satish, lots of puts and takes around adoption curves for sub-6 and for millimeter wave. I'm curious if there is a measurable impact on either orders or demand as Open RAN seems to be maybe gaining some traction. And again, I don't know what the Keysight's content would be into those development efforts, but is that having any kind of measurable impact on demand, whether it be orders or revenue?

Well, first of all, I want to say our 5G platform continues to do well across the ecosystem and on a whole range of applications, so we call it the end-to-end platform, both wireless and wireline, as Ron has mentioned before. I would say the next sort of demand driver in the business continues to be the adoption of the stand-alone version of 5G along with millimeter wave, and then we just had to release 16 version of the standard that just got passed in July. So we have some strong drivers going for the business. When you then compound it with this macro situation that's going on with security concerns around for base stations clearly Open RAN or virtualized RAN has got a lot of interest. And the fact that we have the total technology stack, including Ixia's core network test capabilities that we're now able to purpose to address this opportunity. In fact, this quarter, we just launched our Open RAN toolkit to enable developers there. While there isn't a big player yet that's emerging in Open RAN, there's a lot of customers. It's a broader market space that's emerging with different test needs and interoperability needs. We're participating in the O RAN standards, and we're already starting to book some orders as well.

Next question is from Adam Thalhimer with Thompson, Davis.

Curious for your revenue outlook for Q4, do you see revenue up in both segments? Or is the growth really driven by communications?

Yes. We don't guide at the segment level. So I don't think that's information we want to share at this point in time.

Okay. And then I was hoping maybe you could give some high-level '21 thoughts, just given that two quarters of low single-digit order declines, how that might juxtapose against your thoughts on '21 growth?

Yes. For '21, it's difficult to call even three months out. Obviously, we've got a lot of factors that are at play, including what's the pace of the COVID recovery, what happens with the U.S. elections and those types of things. Again, I think as we look over the longer term, we continue to be encouraged by our relative position in the marketplace. We recognize that those macro factors are going to more or less impact everybody equally. And so not only our market position, but the strength of our portfolio and our technology is going to enable us to weather everything better than most. And so we're very encouraged by that. I did touch on some of the specific headwinds that we're going to be facing going into FY '21, specifically about Huawei. But other than that, we've got a great operating model. I think that's driving strong profitability and cash flow today, and that will continue to do so no matter how the macroeconomy develops over the course of the next several quarters.

Next question is from David Ridley-Lane with Bank of America.

So I wanted to ask how much of the backlog that you built in the second quarter, so you had about a $200 million build, were you able to ship in the third quarter?

Yes, we built backlog again in the third quarter, so there was no reduction in backlog. We are working closely with our customers to address their most urgent delivery needs, and to date, we have not lost any orders due to shipping issues. We consistently revamp production throughout the year and are nearing 100% capacity across all our internal manufacturing. While we do face some supply chain constraints with certain suppliers, we are actively managing those challenges. Looking ahead, we expect our backlog position to remain similar to its current status.

And tactically, I think it's probably pretty obvious. A lot of the orders that we received that went into backlog in Q2 were shipped in Q3. However, the orders that came in Q3, in particular, typically the orders that come in towards the end of Q3 go into the backlog. So although you don't see a backlog change in Q3 or you see one of your roughly $50 million, it doesn't mean we ship those orders and didn't get to Q3. It's always two rolling accounts, and we're always shipping first based on customer requirement. And typically, the customer requirements that we receive from the Q2 orders are things that are needed by our customers before the Q3 orders. So it's rolling. We are clearing out, obviously, what we received in Q2. And then in Q3, we build up again, and it sort of works that way through the quarter depending on the seasonality month-to-month.

Got it. As you consider the situation in August, do you believe it would take about six months to return to a normal backlog age, meaning shipping everything on a regular schedule?

Yes. We're back to, as I said, close to 100% capacity at this point in time and very successfully managing other supply chain constraints. So I think we are right now shipping for an overall schedule and able to meet the demand requirements of our customers.

Got it. And just one last one, if I could. Was there anything unusual in terms of the mix of revenues that was either a benefit or a drag on gross margins?

I would like to highlight that our semi business is currently performing very well, which typically contributes positively to our gross margins. Additionally, our software business is thriving, with a growing recurring revenue stream. Together, software and services make up over 30% of our total revenue, which also supports our gross margins. While services by themselves generally have lower gross margins, we have made significant strides in improving their profitability over the past 18 months. We have successfully reached our long-term goal of achieving over 20% profitability in services, which has improved their impact on our overall margins.

Yes, the services business, which has been part of our growth strategies. That was one of our key elements, continues to grow. Orders and revenue grew double digits. And that is a chain that keeps going. And it helps our ARR. There's no doubt about that. And it has increased our margins. And as Neil mentioned, it's above 20%. And also, software typically grows faster than the rest of our business, and that helps our gross margin. But we produced a real solid 64% gross margin this quarter, and there's nothing really unusual with regard to what we delivered relative to our strategy.

That concludes our question-and-answer session for today. I would now like to turn the conference back to Jason Kary for any closing comments.

Well, thank you, Chris, and thank you all for joining us today. We look forward to speaking with many of you at the upcoming virtual conferences. And with that, I wish you to have a great day. Thank you.

This concludes our conference call. You may now disconnect.