Earnings Call Transcript - KEYS Q3 2021

Operator, Operator

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Second Quarter 2021 earnings conference call. My name is Holly, and I'll be your lead operator today. After the presentation, we will conduct a question-and-answer session. I would now like to hand the conference over to Jason Kary, Vice President, Treasurer, and Investor Relations.

Jason Kary, Vice President, Treasurer, and Investor Relations

Thank you and welcome everyone to the Keysight Third Quarter earnings conference call for the fiscal year 2021. Joining me are Ron Nersesian, Keysight's Chairman, President and CEO, and Neil Dougherty, our CFO. Joining us in the Q&A session will be Satish Dhanasekaran, Chief Operating Officer, and Mark Wallace, Senior Vice President of Global Sales. The press release and information to supplement today's discussion are on our website at investor.keysight.com. Click on the link for quarterly reports under the financial information tab where you will find an investor presentation along with Keysight's segment results. Following this call, we will also post a copy of the prepared remarks. Today's comments will refer to non-GAAP financial measures. We will also make references to core growth, which excludes the impact of currency and acquisitions or divestitures completed within the last 12 months. You will find the most directly comparable GAAP financial metrics and reconciliations on our website. All comparisons are on a year-over-year basis unless otherwise noted. We will make forward-looking statements about the financial performance of the company on today's call. These statements are subject to risks and uncertainties and are only valid as of today. The company assumes no obligation to update them. Please review our recent SEC filings for a more complete picture of risks and other factors. Lastly, I would highlight that management is scheduled to participate in upcoming virtual investor conferences hosted by Jefferies, Deutsche Bank, and Citi. And now, I will turn the call over to Ron.

Ron Nersesian, Chairman, President and CEO

Thank you, Jason. And thank you, everyone, for joining us. Keysight delivered another quarter of excellent results. Solid industry dynamics are accelerating demand for our differentiated solutions and we continue to capitalize on broad-based technology investment across a diverse set of growing markets. Today, I'll focus my comments on three key headlines. First, we delivered record Q3 orders, all-time record revenue, and our highest quarterly operating margin of the year. The durability of our business model was on full display as we continued to effectively navigate supply chain challenges. Second, Keysight's first-to-market software-centric solution strategy continues to yield consistently strong results. Since our launch in 2015, through our expected 2021 finish, we will have delivered 9% compound annual revenue growth and 16% annualized earnings growth, both well above our long-term commitments. Despite significant headwinds of trade restrictions and a global pandemic. Our investments are well aligned with the highest impact market opportunities as we continue to enable our customer success and deliver value to our shareholders. Third, given our outstanding performance year-to-date, we expect to achieve 2021 year-over-year revenue growth of 16% and EPS of $6.03, which represents 24% earnings growth at the midpoint of our guidance. We have strong momentum entering 2022, and our long-term revenue and earnings growth targets remain intact. And we expect to drive incremental margin expansion going forward. Now let's take a deeper look at our third quarter performance. Record Q3 orders of 1.3 billion grew 23%. All-time record revenue also grew 23% to 1.2 billion. We delivered a gross margin of 65%, operating margin of 27%, and earnings of $1.54, which was well above the high-end of our guidance and represents 29% year-over-year earnings growth. Keysight continues to deliver outstanding growth despite year-over-year headwinds due to trade restrictions and ongoing supply chain disruption. Our growth rates are not only just a result of soft year-over-year comparisons but also reflect sustained multi-year above-market growth. For example, Q3 orders are up 18%, and revenue was up 15% versus the same quarter in 2019, prior to the global pandemic. The strength and durability of our business model are delivering as expected. We see accelerated demand from our differentiated solutions, from both existing and new customers. Our customer engagement throughout the pandemic has been strong with approximately 1,900 new customers added in 2020, which we expect to exceed in 2021. Looking at our business segments for the third quarter in a row, we've reported double-digit year-over-year order and revenue growth across both segments and all regions, demonstrating the breadth and differentiated portfolio across a diverse set of end markets. Our Electronic Industrial Solutions Group achieved strong double-digit order and revenue growth across all regions, as well as its fourth consecutive quarter of record revenue. Continued investment in chipsets for 5G data center cloud and AI applications drove demand for our differentiated semiconductor solutions, resulting in another quarter of record orders and revenue. Investment also remains high in advanced technology nodes in capacity expansion for mature processes to address surging global semiconductor demand. Our general electronics business achieved record Q3 orders and revenue. Four consecutive quarters of double-digit order and revenue growth demonstrate Keysight's breadth of contributions across multiple industries. Strength in the quarter was driven by investments in customers' broad-based digital transformation, industrial IoT, digital health, Industry 4.0, and advanced academic research. In automotive, record Q3 orders and all-time record revenue were driven by the ongoing macroeconomic recovery, acceleration in EV and AV technology investment, and manufacturing expansion to meet pent-up demand. As the trend towards autonomous vehicles gains momentum, Keysight remains focused on enabling next-generation technologies across the automotive R&D workflow. We recently announced a new cellular vehicle or C-V2X autonomous drive emulation solution, which provides a real-world environment emulator for in-lab testing to simulate realistic roadway scenarios. We continue to see steady demand for EV and AV solutions, including automotive Ethernet compliance and cybersecurity tests. Our communications solutions group achieved record third-quarter orders in revenue and delivered double-digit order and revenue growth despite trade restrictions that impacted one of our larger customers in China. Aerospace, defense, and government delivered record Q3 orders and revenue. Revenue grew double digits across all major regions. While benefiting from a soft prior-year comparison, growth was again driven by space satellite, electromagnetic spectrum operations, 5G, and early 6G research applications. U.S. government and prime contractor investment were strong, while internationally, Europe rebounded from a year ago, coupled with solid growth in Asia. Our application solution strategy drove a significant win with a leading research institute in this quarter. Keysight's leading-edge integrated wireless and wireline testbed is enabling their next-generation terabit and 6G research. Our aerospace, defense, and government customers will also benefit from our differentiated services offering to enable their mission-critical program needs. In Q3, we entered into multiple U.S. prime contractor engagements for calibration and uptime services. Commercial Communications achieved third-quarter record orders in revenue adjusted for the impact of China trade restrictions. Commercial Communications orders and revenue both grew double digits. Ongoing strength was driven by global 5G deployments and the rollout of new 5G chipsets and devices, ORAN adoption, 400-gig and 800-gig Ethernet for data centers, and increased spending by service providers. Our collaboration with key 5G innovators remains strong as we continue to lead with new industry firsts. In partnership with Qualcomm, we were the first to achieve 10 gigabits per second 5G data connections. Keysight was also selected by Vodafone, along with other industry leaders such as Samsung, NEC, and Dell to deliver end-to-end cloud solutions for the deployment of Europe's first commercial O-RAN network. Our acquired capabilities earlier this year had a strong quarter driven by expanding adoption of our WaveJudge wireless test system, which further enhances Keysight's 5G solutions for deployments. Keysight continues to enable next-generation wireline standards, such as 800-gigabit Ethernet. Our newly announced 800-gigabit Ethernet solutions saw strong demand within the quarter. In a recent partnership with Cisco and Amphenol, we demonstrated high data rate, multi-vendor interoperability, a key enabler of next-generation networks. The combination of our network apps and our leading physical layer Bit Error Rate testers and oscilloscopes is driving new levels of customer insight and value. Higher-value services are driving differentiation while strengthening our competitive position. Demand for our services is exceeding $1 billion. Our growing mix of software and services is increasing the durability of our business model while reducing overall cyclicality. They are both contributing to Keysight's margin expansion with an operating margin at or above the company average. Keysight's focus on operational excellence continues to drive our consistent execution and our employees are critical to our success. Employee growth is a key component of the Keysight leadership model and we view our high-performance culture as a competitive advantage. As such, we are honored to have our team in Malaysia recognized as the overall winner of the employee experience awards by human resources online. This award is in recognition of the innovative team's efforts to proactively engage employees and create positive experiences, despite unprecedented pandemic-related challenges. Our employees in Malaysia have done an outstanding job under difficult circumstances since COVID restrictions were imposed and our production operations were impacted. To mitigate the risk of COVID-19 to employees, customers, and suppliers, Keysight implemented a vaccine program for both Keysight employees and our suppliers. Over 95% of our employees at the Malaysian facility are now vaccinated. In addition, vaccination rates at a large U.S. site are above their local community averages. In summary, our momentum continues, and our strategy is generating strong results. We have a track record of consistent execution and delivering on our commitments. I am confident in our ability to capitalize on many growth opportunities ahead of us as we finish the fiscal year, and look forward to 2022. Now, I would like to turn it over to Neil, to discuss our financial performance and outlook in more detail.

Neil Dougherty, CFO

Thank you, Ron, and hello, everyone. As Ron mentioned, Keysight delivered another outstanding quarter as broad-based technology investment accelerated demand for our differentiated solutions. Resulting in better-than-expected results in the quarter. Third-quarter revenue of one billion was above the high-end of our guidance and grew 23% or 21% on a core basis. We achieved third-quarter orders of $1,310,000, up 23% or 20% on a core basis. Excluding the impact of China trade restrictions, orders grew 29%. Turning to our operational results, we reported a Q3 gross margin of 65%, which increased 60 basis points year-over-year. Operating expenses of $472 million were well-managed despite higher variable compensation. The operating margin was 27%, up over 100 basis points. We achieved a net income of $286 million and delivered $1.54 in earnings per share, which was above the high-end of our guidance. Our weighted average share count for the quarter was 186 million shares. Moving to the performance of our segments, our Communications Solutions Group, or CSG, achieved third-quarter revenue of $875 million, up 15%. CSG delivered a gross margin of 66%, which increased 50 basis points year-over-year. The operating margin was 26%. Commercial Communications revenue of $595 million increased 6%, driven by continued investments across the 5G lifecycle and our leadership in emerging applications. As Ron mentioned, adjusting for the transient impact of unfavorable trade restrictions, Commercial Communications revenue grew double digits. Aerospace, Defense, and Government revenue of $280 million grew 39% and recorded double-digit growth across all major regions led by the U.S. and Europe. The Electronic Industrial Solutions Group or EISG generated another record revenue quarter of $371 million, up 48% or 44% on a core basis. Order and revenue strength were notable across all markets and regions as semiconductor, general electronics, and automotive solutions, orders and revenue all grew strong, double digits. EISG reported a gross margin of 64% and a record operating margin of 31%. Moving to the balance sheet and cash flow. We ended our third quarter with over $2 billion in cash and cash equivalents and reported cash flow from operations of $257 million and free cash flow of $217 million or 17% of revenue. Our capital allocation priorities are unchanged and remain focused on investments in organic growth, value-creating acquisitions, and share repurchase. Under our share repurchase authorization during the quarter, we acquired approximately 570,000 shares on the open market at an average price of $140 for a total consideration of $80 million. Now, turning to our outlook and guidance. We expect the fourth quarter of 2021 revenue to be in the range of $1,250,000,000 to 1,270 billion, which represents 3% revenue growth at the midpoint. Full-year revenue at the midpoint of our guidance is $4.9 billion, representing 16% revenue growth. We expect Q4 earnings per share to be in the range of $1.59 to $1.65 based on a weighted diluted share count of approximately 186 million shares. Full-year earnings at the midpoint of our guidance are $6.03, representing 24% EPS growth. In closing, our expected 2021 revenue and earnings per share represent 7% and 13% compounded annual growth over the last two years since 2019. Both are not only above our long-term expectations but accomplished in the face of significant COVID-related disruption last year and the substantial negative effect of China trade restrictions. Our consistent execution demonstrates the resilience of our business and our ability to drive sustainable and profitable growth. Beyond 2021, our long-term revenue and earnings growth targets, as well as our financial model remain intact as we see continued opportunity for incremental margin expansion. With that, I will now turn it back to Jason for the Q&A.

Jason Kary, Vice President, Treasurer, and Investor Relations

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

Operator, Operator

Ladies and gentlemen, we do ask that you please limit yourself to one question. And our first question will come from the line of Jim Suva with Citigroup. Jim, your line is open.

Jim Suva, Analyst

Thank you very much. Can you hear me?

Ron Nersesian, Chairman, President and CEO

Yes.

Jim Suva, Analyst

Great. Thank you. When I think about the longer term, specifically your end markets, and I look at them, I take a look at automotive, where it looks like you've been underpenetrated or at least a smaller portion of your sales. As you look ahead, is that something that you think could materially be pretty big for the Company in the years ahead, or is there something unique about it? I mean, I look at every car that's being sold out there or the newer ones coming out, they just have a lot more electronics and things that need to be calibrated and tested, or is there something unique about that industry that would prevent you from going into it? Or maybe it's already big for you now, how much is it? Is the profitability the same, it seems like the design times should actually be more favorable because you design a car for multiple years compared to consumer electronics. If you can give us some insights on the automotive strategic view that you may have?

Ron Nersesian, Chairman, President and CEO

Sure. This is Ron. Hi, Jim. If you take a look at our overall automotive business, it is really transforming in a very large way. As you know, the automobile is really turning into a computer with big batteries and a lot of wireless sensors that communicate with many different devices. And that really plays right into our strength. In the old world, the electromechanical car with the combustion engine was relatively low-tech with regard to electronics. Sure, there are transducers and things that are put on suspension systems to look at shocks and engine performance. But more and more microprocessors are in cars, and the whole car itself is really built around electronics that we test, whether it's computers or the wireless sensors for either radar or for 5G, etc. So, we see this as a very big long-term trend for us. As far as production, it depends. Things that are more complex, we're going to have a role in. Things that get reduced to a simple test we won't be playing in that area as it's a very price-competitive market that doesn't really need as much value from us. But in R&D, where we focus, that is the sweet spot for us. So, R&D-focused AV and EV technology are really great opportunities for us going forward.

Jim Suva, Analyst

Thank you so much for the details and congratulations to you and all your teams.

Ron Nersesian, Chairman, President and CEO

Thanks, Jim. The team did a great job.

Mark Niknam, Analyst

Hey guys, thank you for taking the questions. I have one on supply chain and one follow-up. Just on the supply chain, you've obviously managed to navigate through some of the challenges of peers you're seeing. Can you comment on whether you saw any incremental headwinds or even tailwinds or improvement relative to last quarter, and then thoughts on any impact you've embedded into the next quarter's guide? And then my follow-up, you talked about adding 1,900 new customers last year and expecting to exceed that this year. Just any color you can provide in terms of skew or mix, in terms of where these new customers are coming from? Thanks.

Ron Nersesian, Chairman, President and CEO

Sure. This is Ron. I'll start off on the supply chain answer, and then turn it over to Neil as we go forward. And then Mark Wallace, our head of sales, will talk about the excellent progress of our new customers. First, with regard to the supply chain, we've commented on this before. The more complex semiconductors that are in our products, we make right in-house. So, we have a boutique fab that has to produce products that literally have, in many cases, 10 times the performance of commercial products because we're the measurement device, and we have to be more accurate to be able to measure the performance on the commercial devices. That gives us more control of our supply chain, although we do obviously buy parts and some common components from other suppliers. But I think we have an exceptional management team and order fulfillment. We have the largest order fulfillment organization in the test and measurement industry, and I think they've done an excellent job working with our suppliers. There is no doubt that we continue to beat our expectations quarter after quarter. But obviously, if there were more components, we'd be able to take our revenue up a little bit more quickly. Now we'll turn it over to Neil, who will add some more commentary.

Neil Dougherty, CFO

Yes, we are not unaffected by the supply chain situation. However, the vertical integration of our supply chain and our control over the production of our most specialized parts helps lessen the impact. While the impact is not nonexistent in this quarter or in Q4 where we just provided guidance, it is relatively small. Therefore, I don't see it as a significant concern. We are effectively managing our customers' expectations and delivering products on a timeline that they find acceptable. At this point, I cannot cite any examples of orders being canceled due to our inability to manage supply chain risks and deliver products to our customers. That's all I have to say on that.

Ron Nersesian, Chairman, President and CEO

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

Mark Wallace, Senior Vice President of Global Sales

That's right. Thanks, Ron. And Matt, I'll just build on that. As you've heard our results were very broad-based across all segments in all regions. And we put a lot of attention as you hear from these calls on innovating with the industry leaders. Our largest customers are top 20, and they were up very strong, high double-digit. But we added more than 600 new customers during Q3. And as Ron mentioned in his prepared statements, we're on track to exceeding 1,900, which we added last year. This is by design. We have a focus on reaching new customers through a combination of marketing, our direct channel, which, at the end of this year, will be more than twice as big as it was just a few years ago, and through our indirect channel, which is a combination of distributors and our e-commerce platform, where the majority of customers who access Keysight electronically online are new customers. So, I think you could think of it's broad-based across all the segments that we are focused on delivering solutions to today. And it gives us this broader footprint and this higher diversity of customer base that adds to our strength in addition to the top-line growth that delivers quarter after quarter.

Matt Niknam, Analyst

That's great. Thank you, guys, all for the call.

Ron Nersesian, Chairman, President and CEO

Thank you.

Chris Snyder, Analyst

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

Ron Nersesian, Chairman, President and CEO

Yes. I think it's a mix of several of those factors. I certainly don't feel like at this point that we can say the supply chain concerns are behind us. We're continuing to very actively manage the supply chain, and we do expect there will continue to be some limitations on our ability to ship as a result of those supply chain constraints going forward. I think you highlighted some of the efforts that are going on in our services and software business that is resulting in increases in our deferred revenue accounts and the ratable recognition of some revenues. And then I think in some markets, most notably the semi market, we have seen customers look to place orders earlier in the system for delivery later out, just as they're looking to secure supply and communicate their own needs. But we take comfort from the fact that we see the amount of fab construction that is underway, and we believe that those orders, particularly given the relationship that Keysight has with that relatively limited customer set, are very strong.

Chris Snyder, Analyst

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

Mark Wallace, Senior Vice President of Global Sales

Yes. Chris, this is Mark. I will add some more color to that. You have to first start with the baseline that we do business with more than 30,000 customers each and every year. So, we have in more than 100 countries. So, our presence is broad and wide. You did hit on one of the key elements, which is the expansion of various ecosystems. O-RAN is a great example that is accelerating bringing new customers into the 5G ecosystem. And then the success we're achieving in really all the ecosystems is expanding our footprint through that leverage. The other part again that Ron mentioned is the combination of marketing and increased selling capacity is enabling us to reach more customers into some of the more broad-based segments. As an example, in the last several quarters, we saw more education customers turn on, we saw more research. And as we spoke about earlier in the call, it's still early days on the ramp of automotive. And with that transformation from prior internal combustion engine vehicles to electric and autonomous vehicles, we're seeing a large number of new companies and customers that we're serving in all four regions. It's, as I said before, this is a part of our strategy. We've been running this for 5 years, and it's helping us to build this base of customers and accounts going forward.

Ron Nersesian, Chairman, President and CEO

And the only thing I would add to that is if you look at wallet share, you're exactly right. We've expanded into services to get more of our customer's wallet share. We've expanded with our software offerings, and we have added more solutions up and down the communications ecosystem, which clearly gives us a higher percentage of our customer share. But it's also important to take a look at our competitors and just go back over the last 1, 2, 3, 4 years and take a look at our growth rates versus others. And I think you'll also see market share gains for Keysight.

Chris Snyder, Analyst

Thank you.

Ron Nersesian, Chairman, President and CEO

You're welcome.

Joe Cardoso, Analyst

Hi, this is Joe Cardoso, and I have a question regarding the automotive sector. There seems to be a growing excitement around electric vehicles and autonomous vehicles, with both automotive and non-automotive companies looking to capitalize on these opportunities. Can you discuss the competitive landscape in this area? Specifically, are you finding it increasingly challenging compared to the traditional automotive sector, given the emergence of new competitors, and how are you differentiating yourself in this space? Thank you.

Satish Dhanasekaran, Chief Operating Officer

Thanks, Samik. When we consider the significant changes in the automotive sector, particularly in electric and autonomous vehicles, as Ron mentioned, in the electric vehicle area, it’s about utilizing our precise measurements of current, voltage, and other essential parameters to help with range extension decisions. This involves adapting our intellectual property for new applications. There is considerable innovation happening, and we are already engaging with leading innovators and the larger ecosystem forming around this technology. Regarding autonomous vehicles, it's clear that 5G will play a crucial role in their connectivity and the broader technology stack associated with them. Our ability to leverage our strengths in 5G gives us a distinctive edge in this marketplace, which has contributed to some of our recent successes. Additionally, we have recently partnered with Dechra to enhance our testing standards in this market. While it's still early in this space, we are pleased with our results this quarter, showcasing strong growth and a second consecutive quarter of double-digit growth in the automotive sector, with much more potential ahead.

Joe Cardoso, Analyst

And then competitive landscaping tougher?

Satish Dhanasekaran, Chief Operating Officer

Yes. But there's not to the competitive landscape. Clearly, anytime there are traditional competitors that have been in the combustible marketplace that are trying to configure to try to address this opportunity. But as we think about it, the expertise needed and that and the IP needed to play in this space long term, I think we bring a very unique perspective there.

David Ridley-Lane, Analyst

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

Mark Wallace, Senior Vice President of Global Sales

Yes. It's a great question. So again, I'd start by reiterating the points that I made, which I think we've done a really good job of meeting the needs of our customers and getting them the products that they need in timing, which is satisfactory, at least. I think as you know, we've built up a significant backlog. I think that backlog is going to come down over time as the business grows significantly larger now than it has been previously. So, we would expect to be carrying higher amounts of backlog. But I don't expect that there's going to be a one or two-quarter flush of material backlog. I think we're going to work it down over time and continue to meet the needs of our customers working with them on scheduling deliveries as we manage the supply chain constraints and the addition of capacity, which we're still investing in to ultimately bring backlog levels in line with the size of our business.

Ron Nersesian, Chairman, President and CEO

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

David Ridley-Lane, Analyst

Got it. I think this is the first quarter that you've mentioned O-RAN as a factor in driving orders. I know you have been making investments and there's significant interest in the industry. Are you beginning to see tangible orders as a result?

Satish Dhanasekaran, Chief Operating Officer

Yes. O-RAN was the strategic agreement we established about a year ago. We had been involved with the original O-RAN Alliance for a longer period. At a high level, we've recognized that technology stacks will be virtualized to leverage the advantages and flexibility provided by the cloud. A couple of years ago, we acquired Prisma, which brought us unique capabilities that we later combined with our Ixia acquisition. Last quarter, we launched the Keysight open RAN architect capability and have already received a significant order, along with a strong pipeline. This quarter, we made the Keysight open RAN architect available on the Amazon cloud for customers approaching this opportunity from a software standpoint. It’s software testing software. We are very optimistic about our market position. I want to emphasize that multiple open RAN test and integration centers around the world have already chosen us as their core provider. You've also heard about our success with Vodafone, as one of the companies selecting Keysight as a partner for design and testing. We are very pleased with this progress. However, regarding the O-RAN timeline, this is a long-term trend, one we are well-positioned for today, and we will continue to expand this business over time.

David Ridley-Lane, Analyst

Alright. Thank you very much and congratulations on the great results in a very tough market. Thank you.

Ron Nersesian, Chairman, President and CEO

Thank you.

Adam Thalhimer, Analyst

Thanks. Good afternoon, guys, and congratulations.

Ron Nersesian, Chairman, President and CEO

Thanks, Adam.

Adam Thalhimer, Analyst

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

Satish Dhanasekaran, Chief Operating Officer

I'll take this. Clearly, a very strong quarter. Again, building on four consecutive quarters of record, orders, and revenue in the business. We're very pleased with the performance there. With regard to where we play, we're playing in the wafer test, which is on the front end of the semi-process. And given the dynamics that are going on around lithography and the advancements that are playing out, especially driven by 5G and data center applications for 7-nanometer, 5-nanometer, and 3-nanometers, I think all of those new node-size-based opportunities are still in the very early innings because one, those nodes have to get stable and then ramp up. So, it's still very early stages there. So, we view the capital spend for those new node sizes to be fairly stable over time. Obviously, there is a part of the business that is about scaling capacity into mature processes. And we think that will continue given this current semi shortage that is going on and demand being high through '22. It remains to be seen what happens longer-term. It's also important to highlight that given the infrastructure spend that's likely to come into the U.S. and Europe and other regions, looking to localize supply chains, it's one dynamic that's not factored into any of these outlook projections but could have more upside for the semi business. But again, you look at the end-market dramatic drivers, whether it's a new memory topology, or 5G, or data center demand, all of those are feeding into this at this point.

Adam Thalhimer, Analyst

Good outlook. Thank you very much.

Rob Mason, Analyst

Good afternoon. I have a few questions regarding the supply chain. Did you discuss your internal efforts to increase production capacity? I understand that you are trying to boost capacity while managing COVID-related restrictions, so an update on that would be helpful. Additionally, how do you view the seasonality of the business? This past year exhibited muted seasonality for various reasons. Will that trend continue as we move into 2022?

Ron Nersesian, Chairman, President and CEO

Yeah. Great question. So obviously we have been and continue to invest in increasing our own capacity just as a point, we did $4.2 million of revenue last year. We're going to be at $4.9 billion of revenue this year. So, we've added significantly to revenue. Last quarter, we did talk about how within our own factories and subcontractors, we did have some capacity constraints. Those were not gating items for us this quarter. We've added enough capacity that it was no longer the gating item. That doesn't mean that we're done investing as we continue to look forward to the future growth of our business. We're continuing to make investments in further capacity expansion, but right now I feel like we're doing a good job of staying ahead of the curve, and certainly, particularly given that there are some supply chain constraints potentially relieving a little bit of the pressure there. On the seasonality question, I've answered this question many times over the years. When I sit back to model our businesses at the beginning of any year, we tend to think of coming off of Q4 as our biggest quarter of the year as we model sequentially down in Q1, up in Q2, down a little bit in Q3, and then a big finish in Q4 with the highest quarter of the year. That's how I would sit down to model our business. As we talked about all through this year, we expected because of the rebound from COVID, and then more recently with some of the supply chain constraints and the needs for capacity, we expected that seasonality to be more muted this year than it has historically been. And I think that's proven out here over the last several quarters. I think as we look forward, at least over the next couple of quarters, I expect that muted seasonality to remain intact. That doesn't mean there won't be any, I just think that the swings will be less than they typically are, and beyond that, it's hard to call.

Mark Delaney, Analyst

Yes. Good afternoon. And thanks for taking the question. The companies cited trade restructuring into China as a headwind to the growth rate that you reported. I was hoping you could elaborate a bit more on what you've ended up seeing and some of the puts and takes in the context of maybe there are certain customers you're not able to shift to. But to what extent have you been able to offset some of those trade-related headwinds, either as you focus more of your own resources on other customers, or some of the other customers perhaps took market share?

Ron Nersesian, Chairman, President and CEO

Mark, would you like to address that?

Mark Wallace, Senior Vice President of Global Sales

Yes. Yes, I will be happy to. Hey, Mark. As I mentioned before, we did see some uplift from the COVID recovery in certain segments that were really more affected by the impact last year and the early part of this year. You would consider that to be automotive, manufacturing supply chain, the things we've talked about, right, education and research. And then our sales into some of the broad customers, both direct and indirect. So, you know that's a dynamic that we certainly experience. We had some pull-in, as we talked about before, in semiconductor, but it was small, and it really gives us this longer visibility through their forecasts and funnels going out many, many quarters as that are a slower-moving process with fabs and so forth. But again, most of our growth in the quarter still comes from the continuing investments in the areas that we're talking about for next-generation technologies across commercial communications, and aerospace, defense, and eMobility. And we've done a great job of capturing those in all regions, including China, where we get all obviously, that's where the headwinds originate. And this last quarter, we overcame them again, sustaining top-line growth in China, with double-digit growth when you exclude the trade impact. It's really a testament to our ability to pivot to the broad-based business that's available to us in China and the ability to capture that throughout the various cycles. So, semiconductor again, automotive, general electronics. So, we've not only pivoted in China, but we've also captured this around the world.

Ron Nersesian, Chairman, President and CEO

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

Mark Delaney, Analyst

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

Ron Nersesian, Chairman, President and CEO

Yes. We're in Penang in Malaysia. Some of the bigger outbreaks that they did have in Malaysia first occurred in the southern part of Malaysia, not in Penang where we are. But regardless of that, we had a very massive effort to not only vaccinate our employees but also folks that we work with, our partners, some of our contract manufacturers, our shippers that come in. Anybody that gets in contact with us and we have over 95% that have received the first dose as of the beginning of this week. This week, they were getting the second dose. So that feels very good. That's not a constraint right now. But as the orders grow, we'll continue to build that. The constraint is just getting some lower-level components in certain areas but we feel very good about the production capacity that we have in Malaysia, as well as what we have in the other facilities where we do manufacture, as we do some manufacturing in the U.S., we do some in Germany. And all together, it's all built into the guide.

Mark Delaney, Analyst

Thank you.

Ron Nersesian, Chairman, President and CEO

You're welcome.

Brandon Couillard, Analyst

Hey, good afternoon. Neil, just clarification on the 4Q guide. I mean, if the headwinds roll-off in the fourth quarter, a little surprise is that the implied revenue growth in the fourth quarter wouldn't be better than low single-digits. If that's the case, which would imply a deceleration on two to three-year stack comps. It doesn't sound like the in-market to change all that much. You talked about supply chains and trains here and there. But you seem to be managing it fairly well. So, am I missing something here or are you embedding perhaps a little more conservatism around in one particular end market?

Neil Dougherty, CFO

Yeah, no, I think as we've gone through this year, we've been building our ability to ship and our ability to drive incremental revenues as we've gone through the year, right 1180 Q1, 1220 Q2, 1246 Q3. We are guiding to 1260 Q4. So, we're making some stepped-up aggressions. In terms of the year-over-year growth rates, obviously, the Q4 of last year was the big bounce-back quarter after our factories reopened up and revamped, following additional COVID shutdown. And so, we have an unusually tough comparison from a year ago. And frankly, not just on the revenue line, but we've talked about the extraordinarily favorable mix that we saw in Q4 of last year that grew gross margins and operating margins high. And so, I think if you're thinking about it from that perspective, I'd just point really to that tough comp as something that's going to mute growth rates here in the fourth quarter. But we continue to make progress as to adding capacity and continue to making progress in terms of ramping our revenue, and we're really well-positioned as we look forward to FY '22.

Brandon Couillard, Analyst

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

Neil Dougherty, CFO

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

Operator, Operator

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

Jason Kary, Vice President, Treasurer, and Investor Relations

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

Operator, Operator

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