Earnings Call Transcript - KEYS Q4 2024

Operator, Operator

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Fourth Quarter 2024 Earnings Conference Call. My name is Joel, and I will be your lead operator today. This call is being recorded today, Tuesday, November 19th, 2024, at 1:30 PM Pacific Time. I would now like to hand the call over to Paulenier Sims, Director of Investor Relations. Please go ahead, Ms. Sims.

Paulenier Sims, Director of Investor Relations

Thank you and welcome, everyone, to Keysight's Fourth Quarter Earnings Conference Call for Fiscal Year 2024. Joining me are Keysight's President and CEO, Satish Dhanasekaran; and our CFO, Neil Dougherty. In the Q&A session, 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 Wells Fargo and Barclays. And now I will turn the call over to Satish.

Satish Dhanasekaran, President and CEO

Good afternoon, everyone, and thank you for joining us today. My comments will focus on three key headlines. First, Keysight executed well and delivered fourth quarter revenue and earnings per share above the high end of our guidance range under market conditions, which remain consistent with our expectations. Orders finished slightly above our expectations and grew 1% year-over-year and 8% sequentially, driven by ongoing strength in AI and strong year-end bookings in our US Aerospace, Defense, and Government Business. Second, strong execution and cost discipline drove full-year revenue of $5 billion and earnings per share of $6.27, which were down from record highs of 2023. Results were paced by gradual improvement throughout the year with better performance in the second half as expected. Under challenging market conditions, we demonstrated the resilience of our business model by delivering 26% operating profit and over $900 million in free cash flow. We also returned approximately 50% of free cash flow to shareholders through repurchases. Third, we progressed our software-centric solutions strategy by investing to realize organic growth opportunities through innovation and industry collaborations, while expanding the breadth of our solutions through selective M&A. As we look ahead, the strength of our differentiated portfolio, deep engagement with customers, and the accelerating pace of technology innovation give us confidence in our ability to outperform as markets recover. Now let's begin with an overview of Keysight's fourth quarter business performance. Communications Solutions Group revenue was flat year-over-year and grew 6% sequentially with growth across both Commercial Communications and Aerospace, Defense, and Government. CSG orders returned to growth for the full-year, reflecting AI momentum in wireline, stability in wireless, and consistent strength in ADG. In wireline markets, demand remains strong due to ongoing expansion in AI data center infrastructure even as telco investments continue to be muted. As the timeline for 800 gig and 1.6 terabit adoption accelerates, the industry is investing in advanced technologies, including silicon photonics, chiplets, and high-speed electrical and optical interconnects. Keysight continued to expand its portfolio of solutions across the technology stack to enable customers in both R&D and manufacturing. At the Open Compute Project in San Jose, Keysight showcased our newly introduced AI workload and system emulation solution in collaboration with academia and hyperscalers. Our solution provides high fidelity emulation of AI model training and inferencing workloads to optimize training time and benchmark AI infrastructure performance. At ECOC Conference, Keysight showcased physical and protocol AI solutions with industry leaders to enable 800 gig interoperability with critical optical and electrical interface technologies. In wireless, demand was stable as the smartphone industry nears the end of its inventory correction and telco CapEx normalizes from peak levels. Investment continues in Open RAN expansion, ongoing standards progression with emphasis on non-terrestrial networks and early 6G research. This quarter, we announced multiple O-RAN collaborations with industry leaders such as NTT DOCOMO, DISH Networks, and Pegatron. We also collaborated with Qualcomm to establish the industry's first end-to-end interoperability and data connection in the candidate frequency band for 6G FR3. We're also well poised to drive industry innovation forward with our differentiated full-stack solutions. Turning to Aerospace, Defense, and Government, stronger-than-expected seasonality drove orders to an all-time high. The funnel of opportunities remains strong. The US defense budget is expected to grow low-single digits, while government investment in defense modernization in Europe and Asia is projected to increase. Customer engagements on electromagnetic spectrum operations, radar, and advanced communication use cases remain high. Satellite communication investments are expected to continue as more LEO constellations are launched over the next few years. Keysight is capitalizing on the growing investment in defense modernization around the globe. At the recent European Microwave Conference, we showcased our leading capabilities in phased array, over-the-air compact antenna design, and test in collaboration with analog devices. We also highlighted our latest flagship performance network analyzer. Its differentiated and industry-leading capabilities include wide band, high dynamic range, pre-selective receivers for faster S-parameter measurements to enable customers' high-frequency component designs. Turning to Electronic Industrial Solutions Group, revenue was down year-over-year as expected, but grew mid-single digits sequentially. Orders were mixed with year-over-year growth in semi and general electronics, offset by automotive market headwinds. In semiconductor, robust demand drove strong order growth for our parametric wafer test solutions. We saw broad-based foundry investment to expand capacity and address leading-edge applications driven by AI. This included advanced DRAM technologies such as high-bandwidth memory and DDR5 as well as silicon photonics. Enabling further advances in power semiconductor production and efficiency, this quarter Keysight introduced an innovative single pass 3 kilowatt high voltage wafer test solution. In Automotive, the industry is facing challenges, and we expect the headwinds to continue in 2025. This quarter, production-related demand was sequentially stable, while we saw incrementally cautious pending due to slowing EV sales and battery oversupply. Even with near-term headwinds, we remain focused on customers' emerging innovation and design needs. Our R&D engagements for software-defined vehicle, as well as broader electrical and physical design applications remain high. ESI grew its solution business this year through steady renewals and new customer additions. Over this period, the ESI team also made significant contributions to the use of AI to improve product performance simulations and offering workflow solutions with immersive visualization to validate assembly and servicing. In general electronics, we saw stable manufacturing demand, albeit at lower levels, and a modest sequential improvement in consumer and industrial high-speed connectivity applications. Public and private sector investment in support of advanced research and technology workforce development grew this quarter and digital health application demand was again strong. Turning to Software and Services, revenues grew 8% this quarter and accounted for 39% of total Keysight revenue. Annual recurring revenue from Software and Services also grew 16% to approximately $1.5 billion and accounted for roughly 30% of Keysight overall. We saw solid growth in our design engineering software portfolio in 2024 reflecting the expansion of virtual prototyping across a broad range of industries. As a recognized thought leader in RF EDA, Keysight was selected to lead a US government joint public and private sector effort to leverage AI and machine learning to automate and bring efficiencies to complex RF integrated circuit designs. In summary, Keysight has continued to sustain strategic progress and momentum through the downturn. The flexibility and discipline of our operating model has proven our ability to deliver strong financial results and healthy cash flows in a variety of economic conditions. We have positioned the business to emerge stronger as markets recover to capitalize on the opportunities ahead of us and to create value for all stakeholders. Before I conclude, I'd like to sincerely thank our employees once again for all their outstanding contributions, commitment, and strong track record of execution under a variety of market conditions. 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. Fourth quarter revenue of $1,287 million was above the high end of our guidance range and down 2% or down 5% on a core basis. Orders of $1,345 million were up 1% as reported or down 1% on a core basis. Backlog increased $53 million in the quarter to finish at $2.4 billion. Looking at our operational results for Q4, we reported a gross margin of 64.5%. Operating expenses of $497 million were up 5% year-over-year. Q4 operating margin was 26% or 28% on a core basis. Turning to earnings, we achieved $288 million of net income and delivered earnings per share of $1.65. Our weighted average share count for the quarter was 174 million shares. For the full year, Keysight generated revenue of $4,979 million, down 9% as reported or down 12% on a core basis. Gross margin was 65%, down 60 basis points versus the prior year. We sustained investment in R&D at $871 million or 17.5% of revenue, while driving further operating efficiencies in SG&A, which declined 7% excluding acquisitions. Full year core operating margin of 26.5% was down 370 basis points, continuing to outperform Keysight's down cycle model and demonstrating the financial resilience of the business. Net income of $1.1 billion resulted in earnings per share of $6.27. Moving to the performance of our segments. The Communications Solutions Group generated fourth quarter revenue of $894 million, flat as reported or down 2% on a core basis. Commercial Communications revenue of $591 million grew 4%, while Aerospace, Defense, and Government revenue of $303 million declined 6%. Altogether CSG delivered gross margin of 67% and operating margin of 28%. The Electronic Industrial Solutions Group generated revenue of $393 million, down 6% or 11% on a core basis. EISG reported gross margin of 58% and operating margin of 21%, an increase of approximately 100 basis points versus the prior quarter. Moving to the balance sheet and cash flow. We ended the quarter with $1.8 billion in cash and cash equivalents generating cash flow from operations of $359 million and free cash flow of $328 million. Share repurchases this quarter totaled 974,000 shares at an average price per share of approximately $154 for a total consideration of $150 million. Full-year share repurchases totaled $439 million or 49% of the $905 million in free cash flow generated this year. Now turning to our outlook. We expect the demand environment to remain mixed and for recovery to occur gradually through the year, barring any further macro degradation. Our base case assumptions for FY'25 are for revenue growth at the low end of our 5% to 7% long-term target and earnings growth in line with our 10% target. As a reminder, the timing of ESI's annual contract renewals typically results in 40% to 45% of their full-year revenue being recognized in our fiscal first quarter with the balance recognized relatively evenly over the remainder of the fiscal year. For the rest of the business, we are modeling the typical mid-single-digit seasonal decline in revenue from Q4 to Q1. As a result, we expect first quarter revenue to be in the range of $1,265 million to $1,285 million and Q1 earnings per share in the range of $1.65 to $1.71 based on a weighted diluted share count of approximately 174 million shares. Now a few modeling considerations for the full-year. Given the annual ESI contract renewals in Q1, we expect a material sequential decrease in ESI revenue in Q2. And over the same period, we expect a low-single-digit increase in core Keysight revenue. At current debt levels, annual interest expense is expected to be approximately $70 million, capital expenditures are expected to be approximately $150 million, and we are modeling a 14% non-GAAP effective tax rate for FY'25. With that, I will now turn it back to Paulenier for the Q&A.

Paulenier Sims, Director of Investor Relations

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

Operator, Operator

Absolutely. The first question comes from Aaron Rakers from Wells Fargo. Your line is now open.

Aaron Rakers, Analyst

Yeah, thanks for taking the question and congrats on the results. I guess my first question is, I want to ask you about the wireless piece of the business. It seems to be recovering. I think it was kind of mid-single-digit if I'm correct from the presentation order growth in the quarter. I'm just curious of how you, I guess, the past conversations suggested that's more of a stabilizing business as we move through this year. Has that started to change? Has your view of growth kind of recovery in that business started to evolve or deepen as we look through this next fiscal year?

Satish Dhanasekaran, President and CEO

Yeah, thank you, Aaron. Indeed a good quarter. We executed well and capitalized on the opportunities we saw. Specific to your question on wireless, we continue to feel more confident, I would say, after two quarters where the business has stabilized. And we're seeing more strengths on the infrastructure side where there's more activity from customers around Open RAN and 6G research. So that drives that. And on the devices side, it's lagging a little bit where customers still continue to be focused on ongoing standards evolutions. So, I mean, at this point, we continue to believe that the business will remain stable in '25. We'll call it when we see it. But we continue to feel good about the ongoing momentum we're seeing in our wireline business that's driven growth for commercial communications.

Aaron Rakers, Analyst

Yeah and then as a quick follow up kind of sticking with looking at some of the segments. The Aerospace and Defense segment, I'm curious because this question come up with some investors. It sounds like you're pretty confident that, that business continues to progress on the growth profile that you outlined. But have you seen any areas of concern or any kind of churn in programs, et cetera, around some of the federal dynamics of spend? Any uncertainties around that, that you would point to?

Satish Dhanasekaran, President and CEO

Yeah, I think, Aaron, the long-term trajectory of that business is actually the one that is easiest to forecast given the budget clarity that typically gets and the priorities that get set both in the US and in allied nations. If you look at electromagnetic spectrum operations, space and satellite, and other areas, those are the areas where defense modernization investments are moving to and we feel good about our position. Relative to the year, obviously, orders were slightly down year-over-year, but off of a record compare from a year ago. Some of the wins that we had were systems wins, which take us a little longer to ship. So you haven't yet seen that in the revenue line. But as we look ahead, obviously, the short-term with the administration change in the US does bring some uncertainties. Even during times like in 2016, we just had some business more out between quarters, and so we'll monitor the situation, but we feel good about the current situation regarding our business there.

Aaron Rakers, Analyst

Yeah. Thank you.

Operator, Operator

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

Tim Long, Analyst

Thank you. I have two questions. First, you mentioned that AI is driving growth in wireline. Can you elaborate on how significant this business is becoming for you and provide examples of new areas that Keysight is exploring due to AI advancements? Secondly, I want to follow up on software services, which now account for 39% of revenues. Could you discuss how this aspect of your business model is evolving and how Keysight plans to increase that percentage, along with its potential effects on gross margin? Thank you.

Satish Dhanasekaran, President and CEO

Thank you, Tim. Clearly, the wireline business has gained momentum this year driven by AI, but this is one of the examples of proof-of-concepts that I highlighted at Investor Day of last year. We're quite pleased with the way the opportunity has progressed. Our wireline business has exceeded over $1 billion in orders this year, growing at double-digit rates. We service a broad set of customers in that industry, right. You think about silicon designers, system integrators, NEMs, hyperscalers, and contract manufacturers. So it's actually a broad set of customers. But what's driving the activity in AI right now is actually a concentrated set of customers from hyperscalers that are investing in large infrastructure upgrades. So that's the effort. The supply chain right now continues to be constrained. Investments are being made to unlock the supply chain to enable the scale to build. And so we're involved in that. We're capitalizing on that. But as we think about the future, we participated in some forums like the OCP and ECOC earlier this year, and you can start to see the scale expand. It's not yet reflected in the results yet, but we start to build scale around compute, whether it's centralized or at the edge, power and thermal being very big issues for companies. Networking technologies are being adopted, maybe even faster than they were being adopted before this AI became a big trend. Our opportunities we're excited about are not just in the physical layer, but in the protocol layer, allowing customers to emulate how traffic flows through an AI infrastructure and therefore optimize their investments. So we're pretty excited about the opportunities long-term here and capitalizing on the near-term strength.

Neil Dougherty, CFO

Yeah. And then as it relates to Software and Services, obviously, continuing to see a nice mix-shift towards those portions of our business. And as I think the part of your question addressed gross margin, there could be, software portions of those businesses are accretive to Keysight's average gross margin, the services portions are slightly dilutive to Keysight's average gross margin, but overall both the service business has a lower expense structure, so both contribute nicely to profitability when you think about it from the operating margin line.

Mark Wallace, Chief Customer Officer

And then, Tim, I would just add, this is Mark. As far as the expansion, we've shown that it's more resilient to the current macro. Customers continue to invest in new methods shifting left on virtual simulation and emulation of their systems to help reduce costs and increase efficiencies, and we're seeing that. And then the second part, of course, is the further leverage of some of our new assets like ESI, it being exposed to more of our customers in different regions, the US for Aerospace, Defense parts of Asia with a broad Keysight footprint in those regions. We see that as a driver for additional growth as we go forward.

Tim Long, Analyst

Okay. Thank you.

Operator, Operator

Thank you. The next question is from Rob Jamieson with Vertical Research Partners. Your line is now open.

Robert Jamieson, Analyst

Hey, guys. Congrats on the quarter. Just a couple of quick ones from me. Just first on the Communications business. Just what kind of benefit could we see from the funding just in the second half of '25? I mean, is there much benefit there if that funding does get actually released and finally comes to fruition? And then I guess also any potential risk of that being reversed just given some of Trump's advisors at this point that have been anti-BEAD funding?

Satish Dhanasekaran, President and CEO

Yeah, I think the good thing about Keysight's business model in comps and in fact rest of our business is the broad set of customers we serve. That diversity and breadth is a source of great strength during times of change. So while we do pick up some incremental business every year from new logos that come up because they're funded directly or indirectly, there are some direct funding from government at times that flows into Open RAN. We've called some of those wins out and even the CHIPS Act, but we're not heavily tethered to any one of those things. So I would just say that those are incremental in some ways, but not as material as maybe the headlines enthusiastic especially because we're more involved in the R&D side of those labs, and so we feel good. I think the momentum we see because of our renewed focus on go-to-market expansion that we had put in place with marketing is the continued attraction of new logos that we see across our business. It continues to be our focus moving forward as well.

Robert Jamieson, Analyst

That's really helpful. I appreciate that. And then I guess just on tariffs just real quick. You guys have been dealing with this in one way or another for over eight years. Can you just talk about your previous strategies around your pivots in the APAC region, just whether it's been Huawei, ZTE, or even the Trump tariffs, just how you've kind of managed that in the past?

Satish Dhanasekaran, President and CEO

Yeah, I would just say it's probably, it's a question behind the question if I'm understanding you right is what are the implications of the US elections and therefore the policy changes that might ensue. Like everybody, we're monitoring three areas, tax, trade, both tariffs and trade restrictions, and along with defense spending that might ensue. It would be premature for us to comment on them, except to say that we've been pretty agile in ensuring compliance when there is a new government restriction and pivoting our sales resources to go after new opportunities. A potential offset could be, and again I'm breaking my rule and speculating a little bit is if there were to be tariffs of the orders being discussed, many companies are looking to more of China into other areas in Southeast Asia, and we remain prepared to capitalize on the opportunities if that should occur.

Robert Jamieson, Analyst

Got it. Similar to like what we saw with reshoring and everything during supply chain disruptions, the benefit that we saw there.

Satish Dhanasekaran, President and CEO

Exactly.

Operator, Operator

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

Robert Mason, Analyst

Good afternoon. And again nice jump on the quarter. Just with respect to your thoughts around 2025 revenue. Satish, I know you covered some of the segments, but just at a high level, I mean is it fair to think you think all of your major, I'll say segments, again we're talking wireline, wireless, automotive, general electronics, some of these verticals. Would all of them have an opportunity to grow in '25, do you think within the kind of mid-single-digit profile that you're talking about? Automotive sounds like maybe it was the most challenging, but I'd just like to get your thoughts there around all.

Satish Dhanasekaran, President and CEO

Our primary goal was to stabilize the business and return to order growth, which we prioritized for the second half, and I'm glad to say we've achieved that. Currently, CSG has shown growth in terms of orders for the full year, while EISG has not yet reached that point. This gives an overview of the current demand landscape. Looking ahead, we anticipate a continued slow and steady recovery as we approach 2025. We are not assuming that all segments will show improvement in our base case, but if that occurs, we will be ready to take advantage of it. The outlook shared by Neil anticipates a revenue growth of 5% and an EPS growth of 10% for the year.

Robert Mason, Analyst

Yes. Okay, that's helpful. And just as a follow-up, maybe just directed to Neil just with the higher ESI revenue in the first quarter, I would assume that the gross margin will reflect that at least sequentially. Could you maybe give us a little bit of thoughts around your OpEx as you trend in from the fourth quarter into first quarter? There's often some resets. I know seasonality as well influences that, but I'm just kind of curious what kind of trajectory OpEx is on as you enter the new year?

Neil Dougherty, CFO

Yeah, let me just touch on a couple of seasonality-related comments since you've opened the door to that. I think, first of all, as you mentioned with regard to gross margin, with the sizable uptick in ESI revenue, we would expect some gross margin upside from that business in Q1. Similarly, though, then as you move from Q1 to Q2, you have the reverse effect as that revenue comes out of the model. So just if you put it on one side, you've got to take it out on the other side. With regard to OpEx, just reminding you of some things that are kind of the norm for Keysight, we do salary administration for the entire company here in the first quarter of the year. So that will be impacting the P&L starting essentially now. And then as the business inflects from a period of contraction back to a period of growth, we have essentially our variable pay programs turning back on, which will increase OpEx here starting in the first half of next year.

Robert Mason, Analyst

Very good. That's helpful. Thank you.

Operator, Operator

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

Matthew Niknam, Analyst

Hey, guys. Thank you so much for taking the question. On macro, I'm curious if you can speak to how that backdrop has evolved over the last quarter? It seems like there are some pockets that are getting better yet. It seems like others like auto that are maybe a little bit softer. So any general commentary on the macro backdrop you can provide? And then just as a follow-up on Aerospace, Defense, can you talk about maybe what changed later in the quarter? You mentioned a very strong closeout to the quarter, particularly around the US. I'm just curious in terms of what changed and how maybe that's trended into the start of fiscal 1Q? Thanks.

Neil Dougherty, CFO

I'd like to start by discussing the macro environment before handing it over to Mark Wallace to comment on the broader Aerospace and Defense sector. As Satish noted in his remarks, our Q4 results were slightly better than anticipated. Much of that strength was seen in Aerospace and Defense, and Mark will elaborate on that. Regarding macro changes, the automotive sector is currently experiencing the most pressure, with a significant reduction in spending on electric vehicle development which is having a considerable effect on the industry. In terms of wireline, we see a broader stability, and while wireless growth isn't yet robust, there is some stability and positive momentum in Aerospace and Defense. Concerning semiconductors, there's a question of timing; everyone is hopeful for a recovery, but it's uncertain when that will happen. The industrial markets remain a significant uncertainty, largely depending on how the excess capacity created during the supply chain disruptions from 2021 to 2023 is managed, and when companies will begin to reinvest in manufacturing capacity. This is our perspective on the end markets from a macro standpoint.

Mark Wallace, Chief Customer Officer

Yeah, and Matt, I think the Aerospace, Defense, as Satish talked about, the focus on defense modernization has remained a top priority in the US and allied nations. We had a continuing resolution in the first part of last fiscal year, the government fiscal year '24, which put some delays on new program starts. So as we entered into the fourth quarter with the government fiscal year-end in September, we saw increased spend as we normally see, which was not certain because of delays in the budgeting process. So that was a big positive. We see continued investments from the prime contractors as well as the direct government in the US and the prime contractors in Western Europe as well as we've been talking about for many quarters due to the geopolitical situation that continues to unfold. So those factors come together. And then longer-term I think the areas that are promising for us continue to be around EMSO space, satellite, and quantum, with some of the government-funded research that's occurring in all parts of the world continuing to offer us opportunities over the coming quarters.

Matthew Niknam, Analyst

Thank you.

Operator, Operator

Thank you. The next question is from Samik Chatterjee with JPMorgan. Your line is now open.

Samik Chatterjee, Analyst

Hi. Thanks for taking my question. I guess for my first one, Satish, if I can go back to your comments earlier about not really embedding sort of inflection in all of the businesses and your 5% growth target for fiscal '25. How should I think about what kind of recovery or what your expectations are embedded in for semi-cap and general electronics? It seems like both are a bit mixed in terms of what you're seeing, but if you can just outline how you're thinking about those two areas in particular? And I have a quick follow-up after that. Thank you.

Satish Dhanasekaran, President and CEO

Thank you, Samik. For semiconductor fabs, based on our observations and the opportunities we see for our wafer test solutions related to silicon photonics, new memory topologies, and some higher voltage wafers, we believe this strength will continue. However, this is somewhat tempered by a slowdown reported by several semiconductor equipment manufacturers. Nevertheless, we still expect growth in semiconductors from our current levels. Semiconductor revenue accounts for about 10% of our total company revenue. From a broader electronics perspective, we have noticed some stability in manufacturing in Q4. This has led to increased research spending on next-generation technologies and attracted new customers, which has helped return that sector to growth. While it's early to determine a trend based on just one quarter, we anticipate that this stability in manufacturing will persist and support a return to order growth for EISG at some point this year; although it's hard to pinpoint when exactly.

Samik Chatterjee, Analyst

Okay, correct. And for my follow-up, maybe this is more for Neil. I think, Neil, a question you're getting a lot from investors is when they look at some of your previous margin targets that were a bit more longer-term for fiscal '26, you're not really that much different at this point from a gross margin perspective where the guidance was 66% to 67%, but you significantly had a gap to your operating margin target of 31% to 32%. How should we think about the drivers and sort of beyond volume leverage, how you're thinking about other drivers that get you closer to that target or is there something that sort of needs to be re-evaluated relative to those targets? Thank you.

Neil Dougherty, CFO

Yeah, I'd say a couple of things. So first of all, I think we're pleased with how gross margins have held up on the downside of the cycle. Obviously, we've gotten some benefit here from the addition of the ESI software business, but even if you look at the core Keysight business, the gross margins have held up pretty well in total on the downside of the cycle. I think when you start to think about those targets that we put out, 66%, 67% operating margin targets, where again we're 150 basis points, 200 basis points off of that at current levels. But we're significantly further off on the operating margin line. I think you need to look at the impact that the acquisitions are having in the short run where we've made some acquisitions that are accretive to gross margins, but significantly dilutive to operating margins. As we get those businesses integrated and start to operate them within the greater Keysight operating model, there's going to be an opportunity for us to drive significant profit leverage on those acquisitions and start to close that gap on the operating margin side. Thanks.

Satish Dhanasekaran, President and CEO

And Samik, we remain confident in the long-term growth opportunities of this business. And you've seen when we can deliver above model growth rates, the sort of earnings power and leverage we have. We continue to operate this business in a disciplined way to be able to realize those and get us back on track.

Samik Chatterjee, Analyst

Sure. Thank you. Thanks a lot.

Karan Juvekar, Analyst

Hi. This is Karan on for Meta. Congrats on the quarter. So just starting on the Automotive side. Clearly, you remain quite positive on simulation. But outside of that, are there any other exposures that you have within auto that could cause a pickup in the business outside of maybe EV sales improving? And then I have a follow-up. Thank you.

Mark Wallace, Chief Customer Officer

Sure. Yeah, so there are several parts to automotive. The part that we're seeing, the slowdown and project delays is around EV investments that have been quite robust over the last several years with battery test labs. So we're seeing a pause in that. We're seeing manufacturing demand also stay at lower levels, but that's another part of our business that as inventories normalize should see some increasing flow through of manufacturing test for that. The part that's remained steady is the software defined vehicles or the ADAS, the autonomy side, where we have continued innovation crossing over multiple parts of our business into communications, sensor technology, and so forth; and a lot of that is software as well. So there's a lot of work being done in that frame. And the other one that doesn't get as much attention, at least from these calls, but gets a lot of attention on the news is the infrastructure. So the charging infrastructure and the standards associated with those in every region of the world represent additional opportunities that we're pursuing. Long-term drivers of growth, secular drivers around AV, and manufacturing coming back on new advanced technologies remains an area of focus for us over many years.

Karan Juvekar, Analyst

Got it. That's helpful. And then coming back to the AI side. Are there any areas that you see in your portfolio that you could maybe grow content or offer new products to sort of take advantage of the opportunity that you're seeing today? Thank you.

Satish Dhanasekaran, President and CEO

Yeah, good question. I think as we mentioned, the more logical areas which we have seen growth come from to date or results come from to date are associated with the physical layer tools where we provide our oscilloscopes, our sampling scopes, and other tools that we provide. What we're seeing is a bigger opportunity for our emulation platforms. We're still in early pilots with customers on. Again, it's a small, it's a concentrated set of opportunities today. We expect the industry and the impact AI is going to have to be broader, and we're participating in enabling the ecosystem with the right set of tools all the way from design, emulation, to testing; and our focus is on enabling our customers in the R&D parts of the workflow, and it's a pretty rich opportunity for us. Thank you.

Adam Thalhimer, Analyst

Hey, good afternoon, guys. Congrats on the beat. And Mark, congratulations on your retirement.

Mark Wallace, Chief Customer Officer

Hey, thanks, Adam.

Adam Thalhimer, Analyst

I wanted to ask first about the operating margin in Communications. I think that was your best-ever quarterly operating margin. It kind of took me by surprise. Curious what drove that and what the outlook is there?

Neil Dougherty, CFO

Yeah. So obviously, we are very pleased with the results in CSG. Gross margins have held up very strong in that business. Not only do we see a higher software content, higher recurring revenue from software, which obviously helps margins, but I think there's less margin diversity in the CSG portfolio than we see on the ESG side. So less impact from mix. From a profitability standpoint, I think we're very pleased that we're keeping our foot on the gas on the R&D side, continuing to invest to position ourselves to capitalize on the upside while driving significant efficiencies and SG&A resulting in the strong profitability that we saw. So it was the strongest profitability we saw this quarter, not an all-time record, obviously, but very strong operating margins in CSG this quarter.

Adam Thalhimer, Analyst

And then in EISG, as you think about the full-year, what are the growth offsets to the weakness in auto?

Neil Dougherty, CFO

You're talking about in '24 and '25?

Adam Thalhimer, Analyst

For fiscal '25 what offsets in auto this year.

Neil Dougherty, CFO

Yeah, I mean, I think as Satish look forward, as we look to semi and to the broader industrial markets, there is reason for optimism with some of the fab programs and the absorption of capacity that was put in place in prior years. Again, likely to be more back-end loaded. We've talked about at the Keysight level a gradual improvement through the year. As Satish just said, we would expect there is an opportunity for EISG, which has not yet returned to order growth to do so in the back half of the year. I think that would be with some significant increase in the strength of the semi markets and some modest recovery in industrial end markets.

Operator, Operator

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

Paulenier Sims, Director of Investor Relations

Thank you, operator, and thank you all for joining us today. Have a great day.

Operator, Operator

This concludes our conference call. You may now disconnect.