Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Second Quarter 2015 Earnings Conference Call. My name is Kelly, and I will be your lead operator today. [Operator Instructions] Please note that this call is being recorded today, Tuesday, May 19, 2015, at 1:30 p.m. Pacific Time. I would now like to hand the conference over to Jason Kary, Vice President, Treasurer and Investor Relations. Please go ahead, Mr. Kary.

Thank you, and welcome, everyone, to Keysight's Second Quarter Earnings Conference Call for Fiscal Year 2015. With me are Ron Nersesian, Keysight President and CEO; and Neil Dougherty, Keysight's Senior Vice President and CFO. Joining in the Q&A after Neil's comments will be Guy Séné, Senior Vice President of Measurement Solutions and Worldwide Sales; and Mike Gasparian, Senior Vice President of Customer Support Services and Marketing. You can find the press release and information to supplement today's discussion on our website at investor.keysight.com. While there, please click on the link for Quarterly Reports under the Financial Information tab. There, you will find an investor presentation, along with Keysight's segment results. We will also post a copy of the prepared remarks following this call. Today's comments by Ron and Neil will refer to non-GAAP financial measures. You will find the most directly comparable GAAP financial metrics and reconciliations on our website. We will make forward-looking statements about the financial performance of the company. These statements are subject to risks and uncertainties, and are only valid as of today. The company assumes no obligation to update them. Please review the company's recent SEC filings for a more complete picture of our risks and other factors. And now, I'd like to turn the call over to Ron.

Thank you very much, Jason, and hello, everyone. I will start by sharing 4 headlines regarding Keysight's Q2 results. First, our second quarter revenue of $740 million was at the midpoint of our guidance, and our non-GAAP earnings per share of $0.70 was at the high end of our guidance range. We executed well in our second quarter as an independent company, and this is the fifth quarter in a row that we've delivered financial results at or above expectations. Second, incoming orders declined versus a strong quarter last year. Third, in light of slower incoming orders, we have initiated programs in Q2 to reduce our cost structure by $25 million over the next 24 months. And fourth, with the end of our IT support agreement with Agilent in Q2, we have completed the final steps of our separation. With that last separation milestone behind us, our focus now is entirely on delivering value through growth and improving our operational efficiency as an independent company. Now let's move on to the specifics of our results. Second quarter revenue of $740 million were flat over last year, up 3% on a core basis and were at the midpoint of our guidance. Operating profit for the quarter was 20.3%. The business generated operating profit of $150 million and non-GAAP earnings of $0.70 per share. From an end-market perspective, total aerospace/defense revenues declined 1% year-over-year, with strength in the U.S. offset by weakness in the rest of the world. Stable budgets and ongoing program technology investment drove aerospace/defense spending in the U.S. from both direct government accounts and contractors. Outside of the U.S., aerospace/defense revenues were down. Europe and Russia remained weak, while Asia slowed on lighter spending in China. Industrial computers and semiconductor revenues grew 2% year-over-year. Our broader general industrial markets have improved this quarter, while computer and semiconductor markets held up better than expected. Communications revenues declined 3% year-over-year in Q2, driven by lower wireless manufacturing spending. As we expected, last year's strength in 4G base station and infrastructure manufacturing for China has moderated. In addition, capacity expansion for smartphone and smart device manufacturing remains fairly limited. We continue to see steady investment by chipset, device chipset and component customers. Wireless R&D revenues were steady this quarter and continue to track with our expectations of stable investment levels, especially from wireless chipset customers. From a regional perspective, revenue growth was strong in the Americas and grew in all regions, except for Asia Pacific, excluding Japan. Americas grew 19% year-over-year, driven by strength in aerospace/defense and industrial computers and semiconductor market segments. Asia-Pacific revenues, excluding Japan, declined 14% year-over-year versus a strong compare with declines in all market segments. Europe grew 4% on a core basis as strength in computers and semiconductors spending offset weaknesses in Russia. Japan rebounded strongly from a weak Q1 and grew 13% on a core basis with strength in wireless components spending. While we are pleased with our financial results and execution this quarter, our incoming order rate was weaker than expected. Q2 orders of $697 million decreased 11% year-over-year, a decline of 8% on a core basis. Russia accounted for 2 points of the overall order decline due to ongoing sanctions and its economic situation. The balance of the decline was due to capacity build orders placed by 2 large semiconductor and communications customers in our second quarter last year that did not repeat. As we look to the remainder of the year, the weakness in communications is partially being offset by strength in aerospace/defense. There are positive and negative across the industrial computers and semiconductor end markets and overall macroeconomic indicators remain mixed. Accordingly, we initiated several programs that will provide $25 million in total in operational savings that not only offset the dis-synergies associated with our spin off, but also will ensure that our investments are more focused on growth generation through R&D and sales efforts. Coupling this focus with the discipline and strength of our operating model allows us to maintain our investment across the cycle and still deliver solid profitability and cash flow. Therefore, we will continue to invest for the future in 3 key areas that we have highlighted before: wireless communications, modular solutions and software. For instance, carrier aggregation is a key to increasing bandwidth and data rates to create better mobile communications experience for consumers. In Q2, Keysight and Spirent announced a partnership to offer the most advanced carrier-acceptance solution available for testing maximum data throughput performance for LTE-advanced carrier aggregation. The solution was created by integrating our R&D one-box tester platform, the UXM, into Spirent's new carrier acceptance and conformance test solutions. Our modular business had another record revenue quarter, and continued to grow at high double-digit rates. We believe this trend will continue as we leverage state-of-the-art technology from our instrument solutions to deliver unparalleled combinations of measurement performance, speed, size and cost of test for customers. A good example of Keysight solution incorporating multiple hardware and software elements is the 5G solution that we previewed at Mobile World Congress in Barcelona, Spain in March. The solution is for a complex task that is crucial in early-stage R&D to assess performance of proposed 5G network designs. As I mentioned as one of the headlines for this call, we took the final steps in our separation from Agilent with the end of our IT support agreement. With this important milestone behind us, our focus is entirely on delivering value through innovative electronic design and test solutions as well as improving our operational efficiency as an independent company. I will now turn the call over to Neil to provide the details of Keysight's financial results and guidance for our third quarter.

Thank you, Ron, and hello, everyone. Before I review the details of our second quarter, please note that my comments refer to non-GAAP results. You can find reconciliations to the nearest GAAP figures on our Investors Relations website. Turning to our results for Q2. Second quarter revenue of $740 million was flat year-over-year, or up 3% on a core basis, which excludes the impact of currency and acquisitions. The impact of acquisitions was immaterial, though currency accounted for the full 3 percentage point headwind versus Q2 of FY '14. Operating margin for the quarter was 20.3%, down 80 basis points versus the same period last year, as a result of our incremental investment in R&D. The regional breakdown of our revenue was in line with prior periods, with 38% of revenues coming from the Americas, 17% from Europe and 45% from Asia. On a core basis, revenue grew 19% in the Americas, 4% in Europe and 13% in Japan. Asia, excluding Japan, declined 14%. Lower revenue from Russia continued to be a drag on growth. Russia orders and revenue were both down significantly, and we do not expect any improvement in the near term. Moving to the income statement. Currency movements had no material impact on our Q2 operating profit as the unfavorable impact on revenue was offset by favorability in expenses. Gross margins improved 50 basis points versus last year on a similar revenue base due to a higher mix of revenue from R&D versus manufacturing applications and lower warranty expense. Expenses were well controlled, and we continue to invest in R&D at a rate of 13% of revenue. As mentioned, non-GAAP operating margins were just over 20% for the quarter at 20.3% of revenue. After applying our 17% non-GAAP tax rate, we generated non-GAAP net income of $120 million or $0.70 per share. Now turning to cash flow. In Q2, Keysight generated cash from operations of $68 million and invested $16 million in capital expenditures, resulting in 15 -- $52 million of free cash flow. With cash and cash equivalents of $894 million and total debt of $1.1 billion, we finished the quarter in a net debt position of $205 million. Moving to the results of our 2 operating segments. Measurement Solutions generated revenue of $638 million with an operating margin of 20.7% in the second quarter. Segment revenue grew 3% on a core basis, while operating margin improved 20 basis points year-over-year. The Customer Support and Services segment generated revenue of $102 million, a core increase of 3%. After adjusting for the impact of the March 2013 change to our standard warranty period from 1 to 3 years, segment revenue grew 11%. Second quarter operating margin for the Customer Support and Services segment was 17.7%, a sequential improvement of 400 basis points. We are already seeing the benefit of the incremental investments in technology and capacity that we began last quarter. Now turning to our outlook for the third quarter. You should note that Q2 and Q4 are typically stronger quarters for the business, while Q1 and Q3 are seasonally softer. Last year, revenue did grow sequentially from Q2 to Q3, but that deviation from historical norms was the result of a weak first half and an increase in Aerospace & Defense spending post sequestration. We expect to return to our typical seasonality this year, and given our Q2 orders, we are guiding revenues in the range of $635 million to $675 million. This represents a core decline of 10% at the midpoint. We expect third quarter non-GAAP EPS to be in the range of $0.37 to $0.51. Our guidance assumes the exchange rates as of April 30 and the share count of 172 million shares. Our revenue guidance does represent a lower point in our operating model, however, the flexibility of our cost structure will enable us to maintain Q3 operating margin in the mid-teens. In addition to the flexible spending reductions already made, and which are fundamental to our operating model, we have also initiated programs to generate $25 million in structural savings over the next 24 months. These programs will improve our operational efficiency and accelerate the transformation of our company. Two examples of structural actions we have taken include the announcement of a voluntary retirement program and the closure of our U.S.-defined benefit plan to new entrants. These cost-reduction initiatives, in conjunction with our operating model discipline, will enable us to continue making the investments necessary for Keysight to return to market growth while delivering strong profitability and cash flow across the cycle. As a final note, we will be discussing our longer-term strategy and market outlook at our upcoming Investor Day, which is planned for September 1 in New York. With that, I will now turn it back to Jason for the Q&A.

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

[Operator Instructions] And the first question comes from the line of Brandon Couillard from Jefferies. S. Brandon Couillard: Ron, in terms of the 2Q experience and the 3Q guidance, particularly within Communications, could you speak to which markets in particular were weakest, and how the pacing was through the second quarter? And if you could shed some light around what the Communications orders were in the second quarter would be helpful.

I'll make some general comments, and I'll let Guy fill in and provide some more color or commentary. Wireless manufacturing was the weakest segment, by far, and that's where we saw the largest hit. The wireless R&D segment was in the middle, and we actually saw growth in other communication, which includes our optical business or our fiber business that talks more about wireless infrastructure, infrastructure for wireless systems. But the biggest hit that we saw was, in particular, in the overall wireless manufacturing phase. We had mentioned 2 deals in particular that had pulled down our average. One of them pulled down our weighted average core growth 4 points alone. That was for a large deal for near-field communication that we won last year, and we received a significantly large order. That was a one-time shot last year in Q2. Our strategy is to migrate more and more of our portfolio over to R&D and to have a higher percentage of the portfolio in software and recurring revenue through services, software and other products. So we're looking over time to be able to mitigate these manufacturing swings. Guy, anything else to add? Guy Séné: No, I think you mentioned all the points. S. Brandon Couillard: Just one more follow-up, I guess for Neil, in terms of the cost-savings plan. Could you elaborate or give us any color on the phasing of that $25 million over the 2-year period? Curious as to why it's such a protracted period of time. And then, in which areas of the business in particular, product lines? There should be lines in the P&L.

Yes. So I mean, let me touch on that. So first of all, there's kind of 2 efforts that are underway. The short term with the flexibility of our cost structure where we've already began executing our playbook around the short-term flexibility in Q2 when we saw the incoming order rate, and we're accounting on real savings in Q3 to allow us to maintain the profitability in FY '13 -- excuse me, in Q3, in the mid-teens. And so that's a combination of structural things like the fact that a large portion of our -- or significant portion of our sales go through a flexible indirect channel. That we outsource portions of our -- significant portions of our supply chain. And that 100% of our employee base has a portion of their pay that fluctuates with the overall business performance. In addition to that, we are reducing discretionary spending essentially up and down the P&L, with the exception of 2 areas, R& D and field spending, where we're essentially keeping the foot on the gas to make sure we continue to generate orders in the short term and drive growth over the longer term. So that's -- those are the immediate efforts that are going underway. Then in addition to that, we've taken some actions to drive more structural cost savings. Again, we quantified it at $25 million. We do believe it'll take us $24 million -- 24 months to realize the full $25 million in savings. And really, what you're looking at is a number of different programs that will all be running in parallel that will generate savings over time. So I've mentioned 2 of them. One is a voluntary early retirement program. We have a significant portion of our population that's retirement eligible. Obviously, these are employees that have been with us for a long time. They have a lot of institutional knowledge, and what we really want to be able to do is to plan our workforce transition better. And so we will provide them with a bonus to commit to a retirement date, that it will allow us to do some knowledge transfer and then ultimately result in some savings. But it's not the type of thing that turns on overnight, because, again, a big component of that is to understand when they are going to retire and do that knowledge transfer. I also mentioned the termination of our defined benefit plan in the U.S. to new entrants. That will provide savings over the long term, but relatively limited savings in the first year because you need to get a critical mass of people that are on the new program to generate material savings. Another big area of focus is in when you look at what we've essentially just been through as a company, we just spun out from Agilent and, by and large, the process that was followed was to replicate Agilent's processes for Keysight. As Ron has mentioned, we have completed that separation process during the second quarter, and now we're changing our focus towards optimization of those processes. So we now need to look at those processes that were replicated and reengineer them, and that requires some investment, and will take some time for us to realize the savings. So it's going to be a series of different programs that will result in that $25 million savings, and some of it will be realized sooner, and -- but will take us the full 24 months to get it all.

Your next question comes from the line of Richard Eastman from Robert W. Baird.

Ron, could you just kind of spend a minute more just on the orders. And when you talk about the orders geographically, I presume down to 8% in local currency is kind of the number I'm zeroing in on. But is most of the softness, when you speak about geographic orders, is most of that then in Asia, Asia Pac, ex-Japan? Or could you just kind of speak to how orders in the Americas and Europe was, and maybe if there was any strength in any of the application areas? Guy Séné: This is Guy. We definitely have seen a mixed picture across the different regions in terms of orders, and the U.S., the Americas were stronger than the rest of the world. We've had obviously quite some currency impact in Europe where the currency impact had a 10% impact on our total. And Russia is a place where we continue to see ongoing structural weakness due to the situation with the sanctions and the ruble. So Russia has impacted significantly some of the orders we have seen in Europe. Asia, in general, declined on all sectors for revenue, as you heard from Ron. But also the key orders that we mentioned in semiconductor and wireless were coming from Asia, and made Asia then being the place where the orders declined the most. In general, we've seen in Japan, in fact, more flat and going up if we include the currency impact that was still very important in Japan. We have a 13% currency impact in Japan.

Okay. And then just 2 questions maybe for Neil. Could you just talk for a second, within the Customer Support and Services, what's the impact of the deferred revenue or the warranty period pushing that out? As we approach the second half, will some of that annualize? Will we start to see some growth there in revenue? Or is it largely going to stay flattish until we get well into fiscal '16?

Yes, so we essentially have a $28 million per year headwind that goes from essentially the bleeding off of this deferred revenues that was associated with the extended warranty sales. That ends in Q1 -- will materially end in Q1 of FY '16, at which point -- so right now, we're kind of -- we need to generate that $20 million of growth just to tread water, basically. Beginning in FY '16, the compares will essentially get easier, but it will take a year before you start to see meaningful growth because of the bleed off of that deferred revenue.

And is the growth there -- Ron, is the growth there coming on the repair and calibration side? Or again, I know you flush -- you run some of your used inventory equipment through that, but where exactly is the growth? Is it in an attachment rate issue that we're focusing on or...?

This is Mike Gasparian. Let me make a couple of comments about that. Our revenue growth during the quarter for the CSS segment came from a number of factors. The first was our remarketing division, which is, in fact, that Keysight premium used equipment. That value proposition has been very well received internationally, so we're seeing good growth internationally for our used equipment. We're also -- we typically see strong used equipment sales when we have a mixed economic picture or a weaker economic picture. So a number of our major accounts took advantage of our used equipment, which, by the way, does come with a 3-year warranty associated with it. Also in the more traditional service and repair area, this overhang that Neil was referring to was associated with deferred revenue, also, we will be taking a hit until Q2 of fiscal year '16 related to repair and parts because we have another 2 years of repair and parts that are covered under warranty, so we won't see any repair revenue until then. So the repair parts and deferred revenue will all be weak until the beginning of '16. We're seeing really nice growth, however, in our aerospace/defense segment, where we've been pursuing a multi-vendor strategy that's most prevalent in the United States and Europe. So that's providing a really good offset to the declines that Neil commented on.

Okay. And just one last question on -- to you here. But when I look at the guidance for the third quarter at midpoint, so revenue, EPS and walk-up to the EBIT line, it looks like at midpoint, maybe the decremental is approaching 65% sequentially. That seems a bit high. Any thoughts there? Is it just a mix issue or...?

Yes. So -- well, as you know, the decremental is tough. This is really a reset year for Keysight, given the -- essentially that the business is fundamentally different as an independent company than it was as part of Agilent. So you need to layer in the synergies, which are material. You need to layer in the incremental investment in R&D that we are making. And so there -- it's really hard to do those year-over-year incremental/decremental compares given fundamental changes that we've been through.

That's actually -- that's the sequential math from second to third.

Are you looking at -- I'm sorry, I always do my incremental/decrementals year-over-year, so I haven't even done that sequential incremental/decremental look. Obviously, we see a big drop off in revenue. Our ability to -- we are taking action to reduce discretionary spending and minimize the impact. But the actual variable cost of sales on the lost dollar of revenue in the very short run is very significant.

Your next question comes from the line of Patrick Newton from Stifel.

I guess, kind of a multi-part question for Neil or Ron on FX. One is, I want to make sure the negative impact was you said was 3% to revenue in the April quarter. I think I'm calc-ing about a 2% negative impact embedded in the July outlook, if you could confirm that. And then on a competitive basis, given that 2 of your largest competitors are domiciled in Germany and Japan, are you seeing any change to market or pricing dynamics? And do you think that this competitive benefit to your competitors is perhaps impacting the orders for or the Communications business?

Yes, could you repeat the first part of your question about the July outlook? I'm sorry, I missed the first part of that.

I think I'm calc-ing that there's about a negative 2% FX headwind year-over-year embedded in the July quarter outlook, I want to make sure that was accurate.

Yes, no, 3% is what we've modeled.

3% in Q2, 3% in Q3.

That's right.

And the second issue, there's no doubt -- we haven't seen it from Japan, but there's no doubt that we're very competitive with Rohde & Schwarz, our #1 competitor in the RF and microwave wireless world, and we expect there to be some pretty aggressive actions from the competition on the pricing side. That's why we've been working all the cost improvement programs that we work on a continuous basis in the order fulfillment organization, and that's built into our guidance.

Okay, and then I guess as a follow-up. The -- on the Communications side, given that softness, I would assume that the industry growth target, given what peers have said, as well -- is no longer 2.5% to 3.5% in '15 at this point. So do you anticipate that the industry will grow in 2015? And I guess, if -- 2015, no matter what, looks like the fourth consecutive year of a lethargic or no growth environment for both Keysight and the broader industry. Do you see any fundamental changes on the horizon that could spur growth? Or do you see the industry structurally being in a low-growth phase?

I think, right now, I don't see any instantaneous inflections in the business. There is no doubt that there is still more 4G build out to happen. Obviously, there was a big push last year, and there's a little bit of a pause now. But that will continue for years to come. And we're at the early stages of 5G investment, where we're starting to see that in early R&D and everybody to be concerned, so that will help. But there is continuous cost pressure, and we have had -- we have seen margins erode in manufacturing. And that's why we're so determined to shift a higher percentage of our resources in R&D towards winning in our -- our resources to winning in R&D versus winning in production where the margins are much stronger.

And can you -- just dovetailing off that answer, what is the relative size of your production business in Communications versus R&D? I think you said R&D was greater than half last quarter, that may have been for the overall company, but I think that is also true for Communications. Because I'm just -- I think that's a little bit surprising that you're citing that for weakness just in the sense that it was already sub-15, it's been an area that's been pressured for several quarters in a row.

Yes. Well, it was down. There were some large manufacturing builds last year. Matter fact, I think our growth last year was 11% in Q2. And accordingly, we had some big wins as people put in near-field communication. We also saw some people shift their semiconductor providers in another sector, and that created some large buys last year. Both of these are to the tune of almost 2 $30 million orders that didn't repeat. So that was $60 million of the decline alone were those 2 orders, which make up almost 8 points of core growth. But we'll continue to see pressure in that area, but that's why we continue to shift towards more software and more R&D solutions as we move forward.

We have time for one last question, and the question comes from the line of Jim Covello from Goldman Sachs.

This is Chelsea Jurman on behalf of Jim. So gross margin came in a lot stronger than we expected in the current quarter. Can you just talk about the different drivers of the stronger gross margin, and what you're expecting for next quarter?

Yes, in terms of the drivers of gross margin, as Ron has mentioned, we're working to transition more and more of our business to R&D versus manufacturing. That tends to drive gross margins, obviously, as we are on the higher end of technology, gross margins tend to be higher at the cutting edge of technology versus products that are older. And as the technology evolves, what you tend to see is pricing falls and gross margin falls on older products and you get replaced with newer products at the cutting edge of technology that drives gross margin.

And for next quarter?

For next quarter, the biggest -- I mean, the biggest driver is volume, right? Obviously, we're going to see a significant drop off in volume sequentially. And given the product, given the fixed cost infrastructure, that's going to be the biggest driver sequentially.

I'll just make some 3 general comments, or give you 3 different insights as far as what drives it in general. One is, we have a material cost-savings program that we continuously work on to get. The second is the logistic savings. We've been driving those costs down. And the third point is mix. So for instance, when you have a large $30 million order, you can imagine the discount rate on that would be very high. So when you do a comparative, and you don't get that order to repeat, you can imagine the gross margin going up when you're not giving that large discount on a weighted-average basis. And that is one example basically on the mix of large orders versus small orders. But it also happens by different product lines, since we have hundreds and hundreds of product lines that are substantial to our revenue line.

Great. Thanks, that's really helpful. And then as a follow-up, can you give us any update on what you're thinking in terms of capital allocation, and whether you have any sort of preference for a buyback versus a dividend or M&A when you do begin to allocate capital?

Yes. Our first objective, as you can see, I mean, our ROIC this quarter was 39%. You see where our operating model is and what type of returns we provide. But if you really step back and look at Keysight as an independent entity, what we've done in the past is generate a lot of cash, but use that cash to help the Life Sciences business of Agilent grow. And we really need to focus on growth and make sure that we grow and increase our lead as the #1 test and measurement provider. So growth is our first priority. That's why we've talked about increasing our revenue to 13%, still a little bit below industry average, but making a small move there. And we did adjust it, obviously, with the top line being down, so it's 13% of the new number. But we're also looking inorganically at what place makes sense. We do want to make sure that we get a good return above the cost of capital and that it fits strategically within our business. So growth will be our first priority, while providing investors a return on an ROIC above the cost of capital. After that, if we do not have any other good ideas, we will look to returning capital to our shareholders. But at this point, as you look at the history over the last 10-plus years for Keysight as an entity within Agilent, growth is the issue that we think will generate the best long-term shareholder value. Longer term, down the road, we're going to be -- we will be looking at share buybacks and dividends as part of our mix. There is no doubt.

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

Thank you, operator. Actually, I'll turn it over to Ron and -- for your final comments.

Thank you, all, for joining our call. I'm pleased that Keysight delivered another quarter of solid earnings. In addition, we initiated actions to reduce our cost structure by $25 million to adjust to the current dynamics of the industry, to deliver current -- to deliver double-digit profits through the cycle and to maintain our momentum in developing industry-leading solutions. In closing, I'll remind you that our unique formula of combining technology-leading hardware and software and our global network of experts, we are committed to maintaining the discipline of our operating model while investing to grow and deliver long-term value for our shareholders. Thank you very much, and have a nice day.

This concludes our conference call. You may now disconnect.