Earnings Call Transcript - KEYS Q1 2025

Operator, Operator

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal First Quarter 2025 Earnings Conference Call. My name is Joel, and I will be your operator today. This call is being recorded today, Tuesday, February 25th, 2025, at 1:30 PM Pacific Time. I'd now like to hand the call over to Harry Blount, Head of Investor Relations. Please go ahead, Ms. Blount.

Harry Blount, Head of Investor Relations

Thank you, and welcome, everyone, to Keysight's First Quarter Earnings Conference Call for Fiscal Year 2025. My name is Harry Blount. I have long admired Keysight as a market leader in accelerating innovation, and I am delighted to join Keysight as Head of Investor Relations. Joining me are Keysight's President and CEO, Satish Dhanasekaran, and our CFO, Neil Dougherty. In the Q&A section, we will be joined by Chief Customer Officer, Mark Wallace. The press release and information to supplement today's discussion are on our website at investor.keysight.com under Financial Information and Quarterly Reports. Today's comments will refer to non-GAAP financial measures. We will also make reference to core growth, which excludes the impact of currency movements and acquisitions or divestitures completed within the last 12 months. The most directly comparable GAAP financial metrics and reconciliations are on our website, and all comparisons are on a year-over-year basis unless otherwise noted. 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. We assume no obligation to update them and encourage you to review our recent SEC filings for a more complete view of these risks and other factors. Lastly, management is scheduled to participate in upcoming investor conferences hosted by Susquehanna Financial Group and Morgan Stanley. And now I will turn the call over to Satish.

Satish Dhanasekaran, CEO

Good afternoon, everyone, and thank you for joining us today. My comments will focus on three key headlines. First, Keysight delivered strong first-quarter results with revenue of $1.3 billion and earnings per share of $1.82, both exceeding the high end of our guidance. Core revenues grew for the first time in six quarters, reflecting strength in the Communication Solutions Group and stabilization in our Electronic Industrial Solutions Group. Second, orders grew year-over-year for a second consecutive quarter, up 4% to $1.3 billion. We're seeing incrementally positive signals in our sales funnel and customer engagements. Our view of 2025 remains unchanged. We continue to expect gradual recovery even as we monitor the policy changes contemplated by the new administration in the United States. Third, we're well-positioned for the future. The world's most technologically advanced companies trust us to deliver market-leading products and solutions at the physical, protocol, and application layers. The underlying technological trends of more memory, faster processing, greater bandwidths, and lower power remain intact. We are engaging with our customers earlier and more broadly, which gives us confidence in our ability to create value for our stakeholders. Now let's begin with an overview of Keysight's first-quarter business performance. Communications Solutions Group revenue grew 5%, reflecting continued momentum in wireline, stability in wireless, and growth in aerospace, defense, and government. Orders grew for the third consecutive quarter, driven by growth in both wireline and wireless. In wireline, demand remains strong for our physical layer and AI workload emulation solutions, and we saw record orders again this quarter. Keysight is enabling the expansion of the AI data center network and the design of electrical and optical technologies for higher speeds and bandwidth. We continue to see strong engagement from a broad ecosystem, chipset designers, network equipment manufacturers, and hyperscaler customers. At DesignCon, Keysight demonstrated an industry-leading 400 gig per lane test solution enabling 3.2 terabit speeds, along with industry-leading low-power DDR6 memory compliance tests. We believe AI will be a long-term secular tailwind for the design of next-generation technologies in the network, data center, and communications ecosystem. Our wireless business performed in line with expectations and consistent with the stability of the past two quarters, with ongoing activity related to standards progression in 5G advanced non-terrestrial networks and research in early 6G. We saw relative strength in network infrastructure with ongoing innovation in radio access networks and early 6G, while demand remains muted in the smartphone supply chain. In Q1, we launched our flagship PNA-X pro network analyzer to enable the design of advanced components and modules for early 6G research, aerospace defense, and non-terrestrial networks. This solution delivers high-performance capabilities and unmatched measurement speeds while dramatically improving the efficiency of our customers' design workflows. At the upcoming Mobile World Congress, we will be demonstrating PNA-X pro along with other solutions addressing AI, 6G, open radio access networks, and satellite connectivity, many of which will be highlighted in collaboration with industry-leading customers. Turning to aerospace, defense, and government, revenues grew to a first-quarter record with strength in both the US and Asia. The funnel of opportunities remains strong in EMSO, secure communications, space, and satellite, while orders were down in the quarter due to ongoing continuing resolutions. Keysight continues to develop differentiated RF and microwave capabilities for security applications such as radar, spectrum operations, and signal monitoring. This quarter, Keysight had a notable win with a European prime for advanced threat simulation solutions. Turning to the Electronic Industrial Solutions Group, revenue was down 1% and orders were stable, reflecting mixed demand across end-markets. In semiconductor, fab capacity investment and AI-driven demand for advanced node technologies, high-bandwidth memory, and silicon photonics continued to drive strong customer engagement. New fab projects are ramping, helping to drive a third consecutive quarter of strong order growth for our parametric wafer test solutions. In automotive, market conditions remain challenged, reflecting muted activity in manufacturing and EV battery development. Despite the near-term headwinds, customer engagement and innovation remain high in R&D for software-defined applications and autonomous driving. Next-generation autos will require optical technologies for high-bandwidth data transfer and processing within the vehicle. This quarter, Keysight partnered with a fabulous semiconductor company to deliver a new multi-gigabit optical Ethernet test solution. In General Electronics, orders grew for the second consecutive quarter. Customer spending in our industrial end-markets was driven by high-speed PCB and connectivity applications and inventory normalization in the distribution channel. We also saw strong growth in advanced research, particularly in Europe and Asia. We have made strategic progress in growing software and services, which accounted for approximately 40% of Keysight revenue, while recurring revenue was approximately 31% of total revenue. We are seeing growing customer engagement in our Design Engineering Software solutions. And in ESI, we saw new demand in aerospace, defense, as well as industrial customers. In closing, we're pleased that we've returned the company to growth. Our robust innovation pipeline, strategic customer relations, and strong operating and capital discipline position us well to create value for all our stakeholders. I'd like to sincerely thank our employees once again for all their outstanding contributions, commitment, and track record of execution. With that, I'll turn it over to Neil to discuss our financial performance and outlook.

Neil Dougherty, CFO

Thank you, Satish, and hello, everyone. First-quarter revenue of $1,298 million was above the high-end of our guidance range and up 3% on a reported and core basis, while orders of $1,263 million were up 4% on a reported and core basis. Backlog finished the quarter at $2.3 billion. Looking at our operational results for Q1, we reported a gross margin of 65.8%. Operating expenses of $500 million were up 2% year-over-year, and Q1 operating margin was 27%. Turning to earnings, we achieved $317 million of net income and delivered earnings per share of $1.82. Our weighted average share count for the quarter was 174 million shares. Moving to the performance of our segments, the Communication Solutions Group generated first-quarter revenue of $883 million, up 5% year-over-year on a reported and core basis. Commercial Communications revenue of $572 million and aerospace, defense, and government revenue of $311 million each increased 5%. Altogether, CSG delivered a 68% gross margin and a 27% operating margin. The Electronic Industrial Solutions Group generated revenue of $415 million, down 1% or flat on a core basis. EISG reported a 61% gross margin and a 27% operating margin, largely due to a higher mix of software. Moving to the balance sheet and cash flow, we ended the quarter with $2 billion in cash and cash equivalents, generating cash flow from operations of $378 million and free cash flow of $346 million. We repurchased 450,000 shares this quarter at an average price of approximately $167 for a total consideration of $75 million. Now turning to our outlook, we expect second-quarter revenue to be in the range of $1,270 million to $1,290 million and Q2 earnings per share in the range of $1.61 to $1.67 based on a weighted diluted share count of approximately 174 million shares. As a reminder, Keysight's historical first to second quarter revenue seasonality will be muted by the cadence of the ESI business. Looking to the second half, the macro environment is expected to continue to be mixed, including uncertainty stemming from potential US policy actions. Despite this, our base-case scenario for gradual recovery in FY 2025 remains unchanged with assumptions for revenue growth at the low end of our 5% to 7% long-term target and earnings growth consistent with our 10% target. In closing, we are executing well and capitalizing on the recovery as it evolves across our end markets. Our broad and diverse customer base, expanding solutions portfolio, deep customer engagements, and robust innovation pipeline provide a solid foundation for the year ahead. With that, I will turn it back to Harry for the Q&A.

Satish Dhanasekaran, CEO

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

Operator, Operator

Absolutely. The first question is from Samik Chatterjee with J.P. Morgan. Your line is now open.

Priyanka Thapa, Analyst

Hi, Priyanka Thapa on for Samik Chatterjee. So my question is...

Satish Dhanasekaran, CEO

Hi, Priyanka.

Priyanka Thapa, Analyst

What are the upsides from the Commercial Communications segment? My question is on the Commercial Communications segment, specifically regarding the expected breakdown of contributions from wireline versus wireless, given the stability in wireless this quarter and the strong growth in wireline attributed to AI factors.

Satish Dhanasekaran, CEO

Yes, I think you characterized it very well. We saw stability in wireless and some uptick in our infrastructure portion of the wireless business as operator CapEx outlook is getting better. So the smartphone ecosystem continues to be muted in its recovery. So that's the stability picture in wireless. But really the highlight was the strong growth in orders and demand that we saw for our wireline offerings driven by AI.

Priyanka Thapa, Analyst

And what do you anticipate that trend to be in the future, if anything? Do you think it's still going to be wireline stable or do you expect an uptick if the smartphone ecosystem improves?

Satish Dhanasekaran, CEO

In the short term, we believe that wireless will remain stable, which is our base case. There may be some upside as infrastructure spending increases in that area. However, we are very confident that the innovation drivers in AI remain strong, along with the positive investment outlook shared by our customers today.

Operator, Operator

Thank you. The next question is from Meta Marshall with Morgan Stanley. Your line is now open.

Meta Marshall, Analyst

Can you share your thoughts on the current budget environment around the federal sector, especially regarding the ongoing resolutions impacting order weakness in aerospace and defense? Additionally, could you provide some context for the order strength you observed in wireline that would help us understand the strength you mentioned related to AI? Thank you.

Satish Dhanasekaran, CEO

I will, Meta. So let me start with the aerospace defense and then we get to the other piece. I think, look, it's a business I've said before, really difficult to call on every quarterly basis, but you take a long-term view, it's probably one of our more stable businesses to call because the defense budgets keep going up with GDP, and an increasing portion of that is towards technology modernization or what we call defense modernization. So no change to that long-term trend. If I look at the pipeline of opportunities where we have engaged in, it continues to remain strong. I point you to some data points, right? The backlog of prime contractors is at a record level, and the demand for solutions from our customers remains strong. I think we're just balancing typical continuing resolution issues in terms of timing of those deals combined with administration change. So any minor near-term perturbation typically tends to get worked out in a few quarters. That's what we're seeing. But again, we had strong revenue growth this quarter from our aerospace and defense business as we delivered some of the solutions that we have booked last year as well. With regard to AI, I would say that the supply-chain environment for AI remains constrained as capital flows through, and we're seeing a strong uptick in manufacturing for these sorts of high-end capabilities, and we're well-positioned and we're capitalizing on those at this point. But equally exciting for us is the longer-term opportunity coming in multiple dimensions for Keysight's products and solutions. And I would say all the way from the accelerated adoption of technology standards such as PCIe Gen 7, you look at LPDDR6, you look at the 400 gig to 800 gig to increased activity in R&D around the terabit speeds, all of that really creates a very robust pipeline of opportunities that really matches the areas that we had invested in last year, and we're able to capitalize on that. And we feel good about the growing number of collaborations we have in this space with customers because the challenges that they're facing are quite complex as they start to put some of this CapEx to work and start implementing some of these high-speed AI clusters. I think we're making a meaningful contribution, and that's only going to grow with time.

Operator, Operator

Thank you. The next question is from Mehdi Hosseini with Susquehanna. Your line is now open.

Mehdi Hosseini, Analyst

Sorry, I had a hard time unmuting. Apologies for that. I have a couple of follow-up questions. One is near-term and the other is longer-term. Let me start with the longer-term question. Neil and Satish, as you examine your R&D activities and commercialization plans for the coming years, how should we assess the advantages and disadvantages of 5G and 6G compared to satellite communication? Is it possible that by the latter part of this decade, we could see greater commercialization of satellite communication, and would this serve as a complement to the development of 5G rather than a replacement? I have a follow-up.

Neil Dougherty, CFO

Yes, I think that's a fair characterization, Mehdi, that satellite communications, especially non-terrestrial networks and that ecosystem growing in its contribution both for security and for commercial applications, it's an incremental opportunity for us if that's the way you want to think about it for our wireless business in the medium-term. And then 6G clearly is the other major technology driver that we're seeing increased R&D investments at this point, more R than D, but as things slow, eventually lead to standardization, which leads to development and deployment also to come.

Mehdi Hosseini, Analyst

Sure. But what is the net impact on Keysight? Would that actually provide an incremental benefit for Keysight, or is it neutral for Keysight opportunities?

Satish Dhanasekaran, CEO

Yes, whenever you're staring at a new generation of technology, I think it's safe to say that one doesn't see the greatest resolution way ahead of time. But I can tell you just from looking back at the history of every business, you go back to 3G, 4G, and 5G, and there is no doubt that the SAM, if you think of it over a longer period of time, has grown just because of growing complexity. And not to mention, we're still quite early in our innings in terms of expanding our capabilities and really deploying the fullest extent of capabilities of the company. That's been our focus. And I think you should take away that our ability to invest in the downturn last year means that we did not lose any steam. In fact, we continue to grow stronger in terms of our ability to say yes to our customers, participate in early pilots. So I feel good about our position. Hard to really say exactly how big the SAM will be, but if history is any gauge, the R&D opportunity will definitely be bigger, and we're prepared to capitalize on that.

Operator, Operator

Thank you. The next question is from Adam Thalhimer with Thompson Davis. Your line is now open.

Adam Thalhimer, Analyst

Hey, good afternoon, guys. Nice quarter.

Satish Dhanasekaran, CEO

Thanks, Adam.

Adam Thalhimer, Analyst

Can you give a little more color? You talked about a positive sales funnel and encouraging customer engagements. Just curious if that's an indicator that we might be closer to a mixed demand environment becoming a solid demand environment.

Mark Wallace, Chief Customer Officer

Yes, Adam. What I can say is that it's incrementally improving since the last time we spoke three months ago, and it's in line with what we've been speaking about, which is the steady gradual improvement and recovery here in 2025. And we've spoken about our funnel, which goes out about six months, and that six-month funnel is improving in multiple ways. The first is new funnel intake, which is the most important to me, that's new business coming in through the pipeline, and we see that improving, and it's solid as markets do begin to recover, and increasing demand is occurring. The second is velocity. That means how fast customers are making decisions, and that is improving, and we look at that in terms of how much business is created and closed in a particular quarter. And then obviously, the third part, which is the end goal, is having a big funnel, and the funnel is growing, and our short-term funnel, meaning looking out three months, is in support of our Q2 guide. So I think the summary is we have better visibility than we did three months ago. Our signals are generally moving more positively incrementally, and it supports our thesis of a gradual recovery during the year.

Adam Thalhimer, Analyst

All right. Good color, Mark. And then just also can you comment on how EV sales are trending? What the expectations are there?

Mark Wallace, Chief Customer Officer

How can you specify which part?

Satish Dhanasekaran, CEO

How easy are sales?

Adam Thalhimer, Analyst

EV.

Mark Wallace, Chief Customer Officer

Oh EV, electric. Yes. So automotive in general is seeing some constraints in EV sales, particularly around R&D for battery development. However, we are noticing overall activity in e-mobility. As the hardware and software architectures in automobiles start to change with software-defined vehicles and increased communication speeds, we observe a rise in focus and investment from our customers. But based on our observations from the last quarter and our sales funnel, EV and battery testing still appear to be slow.

Neil Dougherty, CFO

Auto manufacturing as well remains soft.

Operator, Operator

Thank you. The next question is from David Ridley-Lane with Bank of America. Your line is now open.

David Ridley-Lane, Analyst

Good afternoon. Can we get an update on sort of the performance of the ESI Group sort of following on that? The question is, is the software aspect also facing budget constraints and so forth? And how are you progressing on sort of your margin targets for that acquisition?

Neil Dougherty, CFO

Yes. So I would say the acquisition remains on-track from a target perspective and kind of a realization of synergy perspective. As you know, it's a high recurring revenue business, and I think we saw renewal rates in the quarter were consistent with expectations. I do think the relative softness in the auto markets that Mark just talked about did unfavorably impact our upsell to those auto customers within the quarter, but that was then offset as we said in our prepared remarks as we started to get traction with aerospace, defense, and industrial customers, kind of newer markets for the ESI product portfolio.

David Ridley-Lane, Analyst

Thank you. And then you have two pending acquisitions coming out of the Ansys and Synopsys deal, right? You have the Optical Solutions Group from Synopsys. And then on the other side of the house, you have a PowerArtist software from Ansys. Are these deals contingent on Ansys going through? And how meaningful are these two on a combined basis just in terms of revenue earnings or some way of quantifying what's in the pipe?

Satish Dhanasekaran, CEO

Yes. The two transactions are contingent on the closure of the Synopsys, Ansys transaction, and to this point, we have not sized those two transactions, but they were excited to add them to our design engineering software portfolio. We have business in both power management as well as optical, and so they're complementary to the physical air tools that we currently have inside our portfolio.

Operator, Operator

The next question is from Mark Delaney with Goldman Sachs. Your line is now open.

Mark Delaney, Analyst

Yes, good afternoon. Thanks for taking the questions. Mark, let me give you my best and wish you well in your upcoming retirement. And Harry, congratulations on the new role with Keysight.

Mark Wallace, Chief Customer Officer

Well, thank you, Mark. Appreciate it.

Mark Delaney, Analyst

And a couple on the financials, if I could. Maybe on operating expenses. I know the company spoke on the last earnings call that as revenue comes back, you'd expect some incremental investments in the business as well as some of the variable cost structure that you have. When I look at OpEx in the quarter, it was only up, I think, about 1% year-on-year. And I think I was looking for a bit more, and as I was thinking about fiscal 2025, I've been looking for mid single-digit OpEx growth this year based on some of your comments on incrementals from the last call. Maybe you can help us understand a bit more what you're doing from an OpEx perspective. Should we still expect some investments over the course of the year? And if so, how much?

Neil Dougherty, CFO

Yes. So I show total OpEx up about 2% on a year-over-year basis Q1 versus Q1. I think what you see, one of the reasons maybe that was a little bit more muted than you expected. Obviously, we were in a bit of a cost-reduction mode last year. All of those were not realized in Q1. And so, we kind of made progress through the year on reductions. And then as we rolled here into Q2, not only have we seen our variable pay expense ratchet up, but the salary administration as we always do in the first quarter of the year, midway through the quarter. So as you think about what's implied in our Q2 guide, we do expect a sequential increase in OpEx as you move from Q1 to Q2. We have a full quarter of those salary increases. Obviously, with the Christmas holidays as well as the Chinese New Year holidays falling as Q1, what significantly impacted lower PTO usage in the quarter, which also puts upward pressure on OpEx. I think as you think about investments, and Satish already alluded to this, our ability to continue to keep core programs on track during the downturn last year and now potentially, as the business returns to growth, start to fund some incremental dollars into things like 6G, quantum computing, and capturing this AI market opportunity for us is something that we're excited about, and there's no shortage of opportunities for us to continue to layer on incremental investment.

Mark Delaney, Analyst

Thank you, Neil. In about 40% incremental margins, is that the right framework if you guys grow the top line mid single-digits for the year?

Neil Dougherty, CFO

Yes, I would say on average for quarters where we're growing 5% or better, you can think about that 40% incremental.

Mark Delaney, Analyst

Okay. And then my other question was just around gross margins. I think it was down a little bit year-on-year. Maybe you could speak a bit on what was driving that in terms of factors like price cost and mix? Thank you.

Neil Dougherty, CFO

Yes, it's mostly mix-related. If you go back and look at the trend lines, we were still to some extent benefiting from the sale of backlog even into Q1 of last year. And then we saw a pretty significant step function down in the Q2, Q3, Q4 of FY 2024. So this was our last really tough compare from a gross margin standpoint. The gross margin performance that we just put up in Q1 is the highest gross margin performance we've had in the last four quarters, which was aided a little bit by the incremental ESI revenue. But again, relative to the past three quarters, there was favorable mix, but compared to a year ago, the mix was less favorable.

Satish Dhanasekaran, CEO

I think just to add a little bit more color to Neil's point, you look at the businesses, which are a lot more R&D indexed, Mark, and the company in CSG, the gross margins are 68%. In the EISG business, as we've talked about, there's a wide dispersion between the manufacturing and R&D businesses, and that's work that Jason's new role is going to continue to do. But if you look at that portfolio last year, that was at 65%, just the mix was so much more favorable, leading to this compare at the company level. But longer-term, we feel good about the opportunity to continue to bear on more R&D contributions to our customers and create greater value for them and the ability to that value as we roll these solutions out.

Operator, Operator

Thank you. The next question is from Matt Niknam with Deutsche Bank. Your line is now open.

Matt Niknam, Analyst

Thank you for taking my question. I have two inquiries. First, Neil, could you provide some guidance on how to view fiscal 2Q orders sequentially, considering the gradual recovery in the business and the various factors related to ESI? Secondly, regarding aerospace defense, you mentioned some weakness in orders due to ongoing continuing resolutions. Satish, could you provide some insight into any potential risks associated with this, particularly in terms of government efficiency and the developments in Washington with the new administration? Thank you.

Neil Dougherty, CFO

Thank you. I'll start by addressing the sequential question. Historically, we see a seasonal trend from Q1 to Q2, and excluding ESI, we typically observe a mid-single-digit increase sequentially. This increase would be counterbalanced by a decrease in ESI, which accounts for nearly 50% of their orders in the first quarter, with the remaining 50% to 55% distributed fairly evenly throughout the rest of the fiscal year. I believe this is a reasonable way to view the situation moving forward.

Satish Dhanasekaran, CEO

With regard to the aerospace and defense, I would say that many of our customers continue to believe that the programs that are already in their backlog from our prime contractor customers are at record levels, and there's unlikely to be a big change to that picture. So those things that are already likely to continue on, and that's a pretty big record level, as I mentioned. So that's number one. And when you look at the global picture in Europe and Asia, you start to see a scenario which is likely to emerge where, given the geopolitical realities, their defense spending as a percentage of GDP is likely to go up. As a matter of fact, if you just watch today, the UK confirmed taking up defense spending just today as well. So I think that's likely to be the trend. And given our technology and capabilities, I think we'll continue to be in a good position to capitalize on those opportunities. With regards to the direct government spending, the RDT&E line item is something that we're watching for, and will remain attentive. But it's unlikely that we see a scenario where there is a significant cut to technology advancement concerning security and defense. But that's our base case thinking. That's sort of what our customers are telling us as well, but no one really knows until these things play out. So we're continuing to monitor that.

Matt Niknam, Analyst

I'm clear about what you're saying. Regarding EISG, as we observe some recovery in that business, do you think we can expect our gross margin to return to the mid 60% range? And Neil, concerning operating margin, I know you've previously outlined a target of 31% to 32%, which was mentioned back in 2023 at Analyst Day. If we continue to see growth in the range of 5% to 7%, do you think it's possible to still achieve that targeted gross margin of 31% or 32% looking ahead to 2026?

Neil Dougherty, CFO

Sure. I will explain and address both questions. Regarding EISG, it will depend on the mix. I do think it will take some time, excluding ESI, to reach the gross margin levels we had in fiscal 2023, which was over 60% before ESI was added. The outcome is very dependent on the mix, as Satish mentioned, and we have discussed this multiple times; there is a wider range of gross margins in that portfolio. Therefore, the nature of this recovery and which businesses improve relative to others will be significant. Now, regarding your second question, let me just quickly recall that. Yes, here it is.

Matt Niknam, Analyst

I was just...

Neil Dougherty, CFO

With regard to operating margin and the 2026 targets, I've said previously that we have not lost sight of that 31% to 32% operating margin target. That still remains our goal. We are likely going to slip on the FY 2026 achievement of that, particularly if the scenario you lay out plays out, which is 5% growth for multiple years. In that case, you could think about 5% growth, 40% incrementals, and do rough math on how long it takes to get back. I think we're optimistic that at some point, we get a little bit more of a bounce-back that allows us to accelerate that momentum. And then certainly, while not contemplated at the time, but the closure of pending acquisitions and ability to realize synergies on these high gross margin businesses may ultimately help us to achieve those objectives.

Satish Dhanasekaran, CEO

Yes, the other thing worth highlighting to Neil's point is, while there are gross margin differences fundamentally between the two groups, we have tremendous organizational synergies between the work we do for our customers. And so you will see even this quarter, even with the gross margin differences, the operating profit between the two groups were spot on, so 27%, so.

Operator, Operator

Thank you. The next question is from Tim Long with Barclays. Your line is now open.

Tim Long, Analyst

Thank you. Satish, I would like to revisit the AI business. Could you elaborate on that a bit? In the past, you've mentioned that it's difficult to quantify the scale of that business right now, but could you outline the top three or four use cases and update us on your customer base and the introduction of new use cases? I'm trying to understand what the future potential looks like for the AI business. Additionally, regarding software and services, it seems we've reached about 40%. Recurring revenues have steadily increased to around 30% or 31%. Can you discuss how we should view that transition moving forward? Should we expect a gradual upward trend, or is there potential for an acceleration in that transition? Thank you.

Satish Dhanasekaran, CEO

Well, let me take the first one. While there's a lot of puts and takes in the near term, I'll just say you take a future state here and say, look, we have about 11,000 data centers today in the world consuming 55 gigawatts of power. In the next few years, there are an additional 63 gigawatts projected of data centers that are going to go online. Just let's think about that as a fact. Then you overlay on top of it this difference between training and inferencing and therefore, all of the edge and inferencing applications that's going to grow. We're already seeing signs of increased processor designs, AI-accelerated cards, and then you layer on reasoning and inferencing applications. So the long-term picture here is pretty robust for us, and we see that picture. We see our customers moving towards that picture, and we're in a great position to be able to intercept that and enable their innovation. And I would say in the near term, we're participating meaningfully in the compute side of things. The 2-nanometer push that's happening, our semi business had a strong quarter again. And we're also working with customers on silicon photonics, which is a very promising technology to come. This is an investment we made about 18 months ago to work with customers. We noted it on a call, and it's proving out to be one of the good bets that we've made that positions us well to participate meaningfully in the compute side of things. If you look at the memory, HBMs, again, DDR6, DDR7, again, areas that we participate today. You look at networking, this move to higher speeds is clearly a factor. And let's not forget all of those interconnects that are going at a rapid pace from 112 to 224 to 448, I mean, requires a lot of high-precision testing because of the cost of failure of these interconnects is very high when you put it in an AI cluster. And again, that's an area we're meaningfully participating. On the emulation side, we've launched this AI data center builder, which is our first platform to emulate high-scale AI workloads that allows customers to get meaningful insight into the time utilization, latency, and cost to train AI models. So we're participating up and down the stack. Again, congruent with our strategy, we feel like we're well positioned in the short and medium-term and really see this long-term bigger opportunity that I'm very excited about. And then with regard to the second question, we've always from the start of the company felt like as a solutions company, we're really focused on this software-centric transformation as we call it. That's a core part of our transformation. We identify areas where we can add meaningful contribution to help our customers in a sustainable way. And obviously, we see 40% as a milestone in that journey, and we're not done by any means. I think there are organic capabilities that we'll continue to launch more new product introductions. I look at our hardware introductions to software introductions ratio or software introductions far outpaced our hardware introductions because it does take longer to launch hardware than software. So that's feeling good. And then as Neil alluded to earlier, as we start to bring in new capabilities that some of them we've announced with Synopsys and Ansys to be played out still, we will start to expand our contributions in the design space and continue to contribute to higher recurring revenue.

Operator, Operator

Thank you. The last question is from Rob Mason with Baird. Your line is now open.

Rob Mason, Analyst

Yes, good evening. Thanks for taking the question. Satish, even in your last response, you mentioned your participation where you're participating in semiconductor. And I think earlier you talked about a third consecutive quarter of good parametric test orders. I'm just, I'm curious if you're starting to build some backlog in that business and if that's the case, if you have what's your visibility on revenue conversion for that?

Satish Dhanasekaran, CEO

Yes, we have seen several quarters of growth in the parametric test segment of our business and we maintain a positive outlook on that opportunity as we anticipate new fab projects coming online. We have accumulated some backlog in the last three quarters, and it's important to note that our main order acceptance window involves opportunities that can be shipped within six months. Therefore, the transition of those orders into revenue is fairly quick.

Rob Mason, Analyst

Understood. And just as a follow-up, just could you touch on your business within China in general, what you saw, how your business trend during the quarter, obviously, there is geopolitical volatility probably. I know in the past when things have emerged, obstacles have emerged, you've been able to pivot to new opportunities. I'm just curious if you're finding yourself needing to pivot in the current environment and if so, what are you leaning into?

Satish Dhanasekaran, CEO

I visited China a few months ago, and I can confirm that our customer relationships remain strong. We have faced some challenges due to geopolitical and trade restrictions, similar to the ones we experienced after Huawei, which have been ongoing. This necessitated a shift in our focus toward customers we can effectively engage with. It's also interesting to note that many of our Chinese clients are adopting a go-global strategy. We are supporting these efforts, whether by helping them relocate their manufacturing to Southeast Asia or North America. Overall, while the landscape is changing, technology innovations are essential for all our global customers, and we are well-positioned as a company.

Operator, Operator

Thank you. That concludes our question-and-answer session for today. I would like to turn the call back to Harry Blount for any closing comments.

Harry Blount, Head of Investor Relations

Thank you, operator, and thank you for joining us today on the call. Have a great day.

Operator, Operator

This concludes our conference call. You may now disconnect.