Ron Nersesian - President and Chief Executive Officer Neil Dougherty - SVP and Chief Financial Officer Mark Wallace - SVP, Worldwide Sales Satish Dhanasekaran - President, Communications Solutions Group Jason Kary - Vice President, Treasurer and Investor Relations

Vijay Bhagavath - Deutsche Bank Jim Suva - Citi Brandan Couillard - Jefferies Adam Thalhimer - Thompson Davis Richard Eastman - Baird Brandon Couillard - Jefferies

Good day, ladies and gentlemen, and welcome to the Keysight Technologies’ Fiscal Third Quarter 2018 Earnings Conference Call. My name is Krista, and I will be your lead operator today. After the presentation, we will conduct a question-and-answer session. [Operator Instructions] Please note that this call is being recorded today, Tuesday, August 21, 2018 at 1.30 PM, 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 third quarter earnings conference call for fiscal year 2018. Joining me are Ron Nersesian, Keysight President and CEO; and Neil Dougherty, Keysight Senior Vice President and CFO. Joining us in the Q&A session will be Mark Wallace, Senior Vice President of Worldwide Sales; and Satish Dhanasekaran, President of the Communications Solutions Group. You can find the press release and information to supplement today's discussion on our Web site 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. Following this conference call, we will post a copy of the prepared remarks to the website. Today's comments by Ron and Neil will refer to non-GAAP financial measures. We will also make references to core growth, which excludes the impact of currency movements as well as revenue from acquisitions or divestitures completed within the last 12 months. You will find the most directly comparable GAAP financial metrics and reconciliations on our website. We will make forward-looking statements about the financial performance of the company on today’s call. These statements are subject to risks and uncertainties and are only valid as of today. The company assumes no obligation to update them. Please review the company's recent SEC filings for a more complete picture of our risks and other factors. I would also note that management is scheduled to present at the Citi Global Technology Conference on September 5th in New York, and the Deutsche Bank Technology Conference on September 12th in Los Vegas. We hope to see many of you there. And now I'd like to turn the call over to Ron.

Thank you, Jason, and thank you all for joining us. We delivered an outstanding third quarter with both revenue and earnings far exceeding the high-end of our guidance. Today, I'll focus my formal comments on three key headlines for the quarter. First, revenue grew 17% or 15% on a core basis to reach a record $1 billion. We achieved this growth while also delivering 45% year-over-year EPS growth, which is a new record for Keysight. Second, customers continue to make strong R&D investments in next generation technologies, and we continue to achieve differentiation and momentum across multiple end markets with our solutions. Keysight orders also grew to over $1 billion and both core revenue and orders grew double digits for the second consecutive quarter. And third, we are raising our core outlook for the year. We now expect 2018 core revenue growth to be approximately 11%, which is an increase from our prior estimate of 7% to 8%. Now let's take a deeper look into our performance for the quarter. We've achieved earnings of $0.89 per share, which was $0.12 above the midpoint and $0.07 above the high end of our guidance. This represents 45% year-over-year earnings growth. We also delivered outstanding order growth for this quarter and reached the new Q3 record. Orders grew 15% in total to surpass $1 billion. On a core basis, which excludes currency as well as acquisitions or divestitures completed within the last 12 months, orders grew 12%. This is our fourth consecutive quarter of double-digit core order growth, and the second quarter out of the last four quarters with orders above $1 billion. Our continued strong order growth has translated into record revenue results. Q3 revenue grew 17%, or 15% on a core basis, to also surpass $1 billion. Broad-based demand and investments in emerging technologies drove double-digit order growth for our solutions and commercial communications, aerospace, defense and governments, automotive and energy, semiconductor and services. Our technology leadership solutions and industry-focused approach continues to advance our footprint in key end-markets undergoing technology transformations. We are seeing excellent adoption of our solutions within marquee Keysight customers. Additionally, we are adding new customers at a rapid rate. In total, we have added close to 2,000 new direct customers so far this year. This quarter, we saw very strong 23% revenue growth in our commercial communications end-market. Broad 5G related R&D investment continues to increase across the wireless ecosystems, which includes chipsets, devices, networks and infrastructure. Our early engagement with the market leaders and our advanced portfolio of 5G R&D solutions continue to strengthen Keysight's leadership position in 5G. In Q3, this translated triple-digit 5G order growth. We are the broadest array of 5G solutions on the market today and continue to see strength globally for our 5G program. We are engaged with lead operators around the world such as NTT DOCOMO in their 5G deployment process. This quarter, our Ixia Solutions Group along with our Nemo Solutions team from the Anite acquisition, secured key design wins for a leading edge RAN and core network solutions for 5G, which is just another example of our differentiated portfolio of solutions. Speaking of Ixia, we were pleased with Ixia’s improved revenue performance after our expensive integration activities last quarter. We are continuing to make good progress in optimizing the business and we have a healthy pipeline of opportunities. Ixia was also seeing increased 400G activity. Our recently announced AresONE high density 400 gig Ethernet test solution, one best of show at Interop Tokyo and its gaining strong interest from customers. Automotive and energy is another area where we continue to see strength in the quarter, delivering our seventh consecutive quarter of double-digit order growth in Q3. Demand was driven by broad strengths across all regions, expansion within our top customers and wins with new accounts in the quarter. Major automotive OEMs and Tier 1 suppliers continue to aggressively invest across a broad set of automotive electronic applications. This is driving growth for both R&D applications and the associated solutions supporting high value manufacturing test. In the aerospace, defense and government end-market, we delivered double-digit order growth for the fourth consecutive quarter and increased revenue by 22%. In the quarter, we saw strong worldwide demand across the aerospace and defense supply chain, including space, satellite, radar and electronic warfare applications. Looking forward, in this end market, we are seeing some headwinds in China from growing trade tensions, but expect them to be offset by growing demand in the rest of the world. In the U.S., the defense budget for 2019 was passed last week. We expect to benefit from the year-over-year budget stability, as well as the significant increases in U.S. spending for research, development, test and evaluation. Across our end markets, software and services are key components for the value creation we deliver to customers. In the third quarter, revenue for our software solutions grew double-digits. We continue to see increased demand in next generation technology design as the complexity of that design increases and design cycles accelerate. Our long-term strategy to drive growth in services is also yielding results. Services orders grew double-digit and revenue grew 9% year-over-year, driven by calibration, remarketed solutions and repair. Customers' success in providing leading edge technology solutions and insights is at the core of Keysight’s leadership model. The growth we have achieved over the past several quarters were not have been possible without our commitment to innovation and the continued targeted investments we have made over the past several years. We have significantly strengthened our technology leadership in key areas of the market undergoing multi-year transformations and growth trends. We will continue to focus our investments in these key growth areas to drive innovation, create even more value for our customers and outgrow the market. Lastly, we have an amazing team at Keysight, and I thank them for their commitment to both our company and our customers. Attracting and fastering and retaining top talent across the globe as well as creating a culture of diversity and inclusion will be contributing factors to our future success. Demonstrating KLM in action this quarter, I would highlight the career comeback program we have in Malaysia for our largest manufacturing facility is located along with the sizable R&D center. I'm proud to say that through this program, we have a growing number of mothers who have returned to the workforce bringing their expertise to the company in various areas, including the electrical engineering, software developments, human resources and supply chain. We look forward to sharing with you the success of the Keysight leadership model in the quarters and years to come. I will now turn it over to Neil to discuss our financial performance and outlook in more detail.

Thank you, Ron, and hello everyone. Before I get started, I will note that all comparisons are on a year-over-year basis unless specifically noted otherwise. As Ron mentioned, we delivered an exceptional quarter as we continue to execute on the strong demand we see in core areas of our business, additionally our continued focus, execution and commitment to operational discipline is delivering record results for Keysight. For the third quarter of 2018, we delivered record non-GAAP revenue of $1 billion, which was well above our guidance of $942 million to $972 million. In Q3, we also delivered $1 billion in orders, which were up 15% with core orders growing 12%, enabling us to exit the quarter in a solid backlog position. Looking at our operational results for Q3, we reported gross margin of 61.2% and operating expenses of $402 million resulting an operating margin of 21.3%, which is the highest level in Keysight's history. We also achieved record net income of $170 million and delivered $0.89 and earnings per share, which was up 45%. Our weighted average diluted share count for the quarter was 191 million shares. Moving to the performance of our segments. Our Communications Solutions Group, or CSG, generated total revenue of $515 million, up 23% while delivering gross margin of 61.7% and operating margin of 22.2%. In Q3, Commercial Communications delivered revenue of $314 million, up 23%, driven by increased 5G R&D demand across the wireless ecosystem and growth in datacenter next generation 400 gig and high-speed digital tests. Aerospace, defense and government grew 22% and generated revenue of $201 million. As Ron mentioned, aerospace, defense and government growth was robust with strong demand across the aerospace, defense supply chain including space, satellite, radar and electronic warfare applications. Our Electronic Industrial Group, or EISG, generated third quarter revenue of $258 million, up 19%, driven by strength across all of its markets, automotive and energy, semiconductor and general electronics. EISG reported gross margin of 63.1% and operating margin of 28.5%. Our Ixia Solutions Group, or ISG, reported Q3 revenue of $119 million, gross margin of 75.6% and operating margin of 8.1%. We were pleased with ISG's improved revenue performance after extensive integration activities last quarter. We continue to focus on optimizing processes in several key areas and are confident in our ability to grow the business and increase profitability. Lastly, Services Solutions Group, or SSG, revenue grew 9% in Q3 to reach $116 million, was lowering 40.1% gross margin and operating margin of 15.0%. Q3 services revenue was driven by growth for calibration, remarketed solutions and repair. Moving to the balance sheet and cash flow, we ended our third quarter with $742 million in cash and cash equivalents and reported cash flow from operations of $38 million and free cash flow of negative $2 million. This includes accelerated funding of our U.S. pension plan and we now have $85 million in order to secure tax deductibility at the current corporate rate prior to the new tax legislation taking effect. Excluding this accelerated payment, free cash flow was $83 million, which represents 8% of revenue. Under our existing share repurchase authorization during the quarter, we acquired approximately 668,000 shares on the open market at an average price of $59.81 for a total consideration of $40 million. Before moving to our guidance, I would like to make a few additional comments about the potential impact on our business from trade tensions between the U.S. and China. We currently estimate that the expense impact from the announced tariffs is still relatively immaterial. We are also closely monitoring the potential impact of these tensions on our aerospace and defense business in China, which we currently estimate $10 to $15 million per quarter. As Ron mentioned, we believe this will be offset by the strong demand trends we are seeing in the rest of the world aerospace defense market. Now turning to our outlook and guidance. We expect fourth quarter revenue to be in the range of $1 billion to $1.20 billion, and Q4 earnings per share to be in the range of $0.85 to $0.91, based on a weighted diluted share count of approximately 191 million shares. At the midpoint, this brings our earnings growth for 2018 to 23% and total revenue growth to approximately 19% or 11% on a core basis, which is an increase from our prior estimate of 7% to 8%. Additionally for the year, we expect to deliver a year-over-year core operating margin incremental at or above our 40% target. With that, I will now turn it back to Jason, for the Q&A.

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

[Operator instructions] And the first question comes from the line of Joseph Wolf with Barclays. Your line is open.

Hi, this is Peter [indiscernible] on for Joseph. Thanks for taking my question. Circling back to 400G, I recall last quarter you had said that you were starting to see some manufacturing activity in addition to just the R&D. Has that firmed up a bit? Can you quantify that a little bit?

This is Satish. I’ll take that. We continue to see more activity in R&D both in the U.S. and rest of the world. Manufacturing -- early manufacturing is starting, but at this point we believe that most of the big manufacturers of RANs are out in the 2019 timeframe. Thanks.

Okay, thank you, and just one follow-up. Could you give us a sense of how much of the growth that you're seeing from 5G? How much of that is slowing into SSG in terms of the recurring services that will be, that will occur post-installation if at all?

Yes, the 5G growth numbers, we are reporting, are only the 5G revenues that reflect within the Communication Solutions Group. And they do not reflect any services business at this point in time.

Great. Would that be along the same lines as your other businesses once it's sort of rolled out?

Yes, that's running at roughly the same ratios where the equipment that's used for 5G is repaired and calibrated just as all the other equipment we sell for 3G or 4G or other technologies. So it's a pretty standard ratio at this point.

Thank you.

You're welcome.

And your next question comes from the line of Vijay Bhagavath with Deutsche Bank. Your line is now open.

Yes, thanks. Hey congratulations, great results here Ron, Neil.

Thank you, Vijay.

Honestly that's well deserved. So my question is around 5G, in particular, and then I have a follow-up for Neil. The 5G question would be, I mean, Verizon, in particular, quite affirmative on big plans at 5G broadband, I mean they announced in Indianapolis recently. So as we fast-forward into next year, Ron, would some of these order strength start cooling off as service providers like Verizon get into production or not really? I mean that's kind of the most frequently asked question from clients. Thank you.

Thank you, Vijay. Let me take this question. I think you know our -- we've shared our strategy to really work with the entire ecosystem all the way from chipsets to datacenters, and that's kind of the flow that we've been following. And what we see that's really resulting in these results is, number one, very strong industry acceleration, not only from the operator that you've referenced but multiple leader operators globally, so that's the first sort of driver. Second, with the standards just finalizing the Release 15 version of it, we've seen unleashing of about 673 entries of new features and over 866 band combinations. You combine these things together, we're going to be in R&D phase for long time to come, okay? Now I'll answer the question you just mentioned. There are some early sort of signs of manufacturing, in fact in this quarter, we had our first design win in manufacturing also to simpler some of the trial initiatives of our key customers.

Very helpful. Quick follow on for Neil. Things are going well, Neil. So how do you keep OpEx in check and in control? Thanks.

So my point to our business model where we have overtime worked very hard to increase the flexibility and the portion of our dollars that are discretionary. And it's our job to manage that. And as we mentioned on the call, we expect to deliver the 40% operating margin incremental for this year, and feel like we are well positioned from that standpoint going forward. And just to wrap-up, at our Analyst Day in March, obviously, we put our targets for 2021 where we're looking to increase the overall level of profitability in the business to 23% by that period of time. So we do have work to do to drive that incremental level of profitability, but those actions are well underway.

As we look through our budgeting process, we just don't go ahead and layer on what our topline revenue growth is and then add more expenses, we go through a process that we're in the middle of right now, we call zero-base budgeting, where we started the floor and we say, okay, what are the most important things to move the needle from where we are today to where we want to get to in the future. And that I prioritizes our expenses making sure that we have a good ROI at either being defensive or being offensive, which is our top priority. So by doing that we're able to go ahead and continually improve the operating model and hit the 2021 targets.

Thank you. Very helpful.

Thank you, Vijay.

And your next question comes from the line of Jim Suva with Citi. Your line is now open.

Thank you very much. In your prepared comments, you made some comments about the U.S., China, some tariffs, some costs and demand offsets. Can you just give a little bit more details or help us better understand kind of what you're building in and again, walk me through the costs and the savings and offsets there again. Thank you.

So, yes, I'll take that. This is Mark Wallace. So just to reiterate a couple of the points that were made at the -- in the prepared statements from Ron and Neil. So far, as we've looked at the tariffs that have been announced, the impacts are very small, immaterial. And separate from that, the trade tensions are -- and the restrictions are principally affecting our aerospace defense business in China. And as Neil mentioned, based on the current situation, we estimate that impact to be $10 million to $15 million per quarter. Now, if you take a step back, and I think Ron mentioned this as well, the strength of our aerospace, defense business globally is very strong, and we feel like the rest of the world will offset this impact to China. This is our fourth quarter in a row of double-digit order growth and we continue to see increased investments around the world, especially in the U.S. As Ron mentioned, the U.S. DoD bill, the Defense Appropriations bill has been signed before the beginning of the new fiscal year. I think this is the first time that's happened in more than 20 years. And our overall business in aerospace, defense remains very broad from satellite to MilCom radio test to electronic warfare and radar test. So it's a very large market and it’s a growing market that we're playing a big role in. And then finally back to China, just for a moment, we continue to actively monitor the situation and despite the trade tensions, our business in China continues to be strong and broad. We delivered solid double digit revenue and order growth in Q3, and we're continuing win in China with our differentiated solutions for 5G, for automotive, for semiconductor, et cetera.

And we're not just taking a look at the advancements in the U.S. in their actual budgets going forward, and picking up obviously growth on that front. But even in China, what we're doing is we're redeploying some of our sales force to focus where there is business. So we dynamically allocate our resources to optimize our overall China business inside and outside of aerospace, defense, and we're capitalizing on the U.S. and our friendly neighbors that are increasing the aerospace, defense budgets. And as Mark mentioned, not only do we expect to see a traditionally seasonally high September or end of this fiscal year, the budget has already in place for 2019, which we haven't seen in decades.

And then my follow up is on Ixia and the integration. Is it fully integrated or kind of what I say the top handful things have been done and what are the top handful of thing are still yet to come? Thank you.

Yes, so we've talked about our big integration efforts last quarter, obviously, moving them into our ERP, shifting them from their legacy contract manufacturing into Keysight's contract manufacturing environment. The heavy lifting on those things is done. We have been working first to stabilize and revamp the business and we're very pleased with the results that we got this quarter. Obviously, we saw approximately $30 million increase sequentially in revenue. We saw 16 percentage point improvement in operating margins. But we're not satisfied with the overall level of profitability in that business. We're continuing to work on that. We have additional profit improvement plan for this quarter as we continue to make progress, and in the -- optimizing the operation of that business within the Keysight environment.

Thank you very much for the details.

You're welcome.

And your next question comes from the line of Brandan Couillard with Jefferies. Your line is now open.

Ron, just at a high level, I mean, it seems incremental broad-based strength sort of across the business. How much the growth as you sort of attribute to underlying end markets getting better versus Keysight gaining share, and some of the things you may begun the new product front or the commercial sight where are you just in the right places at the right time?

Sure, well I think it's a mix. The first thing that we did when we were reforming the company even before we went public was to identify where are the growth opportunities and what's the resources, where there is strength in the markets. And accordingly we focused on 5G, we focused on automotive and energy, we also focused on building out our services business and the list goes on. So I think we done a good job of picking the markets that actually have a higher secular growth rate relative to the other broader electronic measurement markets. On top of that, from what we can see, we believe very strongly that we are gaining share with our 11% organic revenue growth this year and much, much higher when you look at our total revenue growth. So we also, if you take a look at the core growth that we've reported versus some of the other players, I think our core growth really shows the underlying strength of the business. So Brandan, it is a mix of the two. The markets are strong, but we have taken Keysight to a point where we are outgrowing the market without a doubt compared to a time when we were with adjuvant where we were not. And the investments that we put in place are providing great returns all the way to the bottom line.

Thanks. And then really, I think, maybe little bit early to start talking about fiscal '19 at this point, but any preliminary views you can sort of share with us in terms of how you're thinking about the topline growth next year? I mean on one hand, you'll be lapping tougher comps, but you should be lapping the easier comps of the Ixia business, some of that continues to sort of rebound on a quarter-over-quarter basis. I mean, how do we think about fiscal '19 relative to your longer term model of 4% to 5%. Is it reasonable that that might be a little bit better than the long term model? Thank you.

Yes, Brandan, it's a great question. Obviously we're very pleased with the high level of growth that we put up this year, 11% core growth for the year. And as you mentioned, that is going to approve present some stronger comps for us as we go into in FY '19. As we look at that though, we are still seeing continued strength in many of our end markets, 5G, automotive services, software, are all areas that continue to put up strong numbers. We've mentioned some of the areas that we're monitoring, being the China trade situation, the continued strength in SEMI that feels like it has to cool off at some point. We're not seeing that as of where we are today. I think as we look forward to -- as we look forward to FY '19, I do feel like we are in a stretch with the market help where there's opportunity as for some upside to that 4% to 5% long term model.

And your next question comes from the line of Adam Thalhimer with Thompson Davis. Your line is now open.

Hey, good afternoon guys. Congrats on a great quarter.

Thanks, Adam and welcome. Thanks for joining us. I think this is your first call with us.

Yes, sir. Yes. I wanted to ask first high level, can you talk a little bit about expectations for orders in Q4? Because I know you are starting to comp against the tougher comps Q4 last year, particularly in communications.

We don't report orders, so we don't guide orders going forward. You could take a look at what we guided for revenue that we believe is pretty strong. As you noticed, this quarter, our book-to-bill was approximately 1.00 or we delivered that $0.89 EPS, and that revenue growth without even eating into our backlog. So we're very, very pleased with where we are now. We haven't seen our order rate slowdown relative to our revenue growth rate. There is a slight difference in numbers, so you get a slight different percentage. But overall, we've been running basically with orders in revenues equal to one.

Okay. And then I wanted to ask that EISG margins were really solid in the quarter. Can you provide any thoughts on what drove that and, perhaps touch on sustainability of that trend?

Yes. So this is Neil. I mean, obviously, the biggest driver of that was the topline trade within the ISG. The R&D investments within EISG are lower than in some of our other businesses. But we're seeing broad based strength across auto and energy, general electronics, semiconductor measurement, and so we are able to get a high a degree of leverage in that business when it is growing at these levels.

What I will add that, if you look at the three markets that we break down, which is auto and energy, the general electronics and semiconductors, all three of them had double digit revenue growth. So that's very strong and when we have very, very solid management of that P&L as we do in the other businesses, and therefore we can certainly drive it to the bottom line. The semiconductor business has higher margins and that was one of the three businesses that had higher -- high revenue growth in double digits.

Perfect. Okay. Thanks for taking the questions.

Thank you.

Your next question comes from the line of Richard Eastman with Baird. Your line is now open.

Yes, good afternoon, and fantastic quarter. Some real nice work.

Thanks Rick.

Ron, could you maybe just speak for a second to Ixia, when I look at the revenue number, certainly year-over-year, it looks like the business is now stable from a revenue perspective. I'm curious a little bit around order growth there. And also is the tone of the business now that you haven't integrated stable revenue. Should we start to think about get into that targeted mid-single digit growth rate in '19 for Ixia?

I'm going to let Mark Wallace to make a couple of comments, but you're exactly right, Rick. We have -- the integration has stabilized that business. There was a lot of work at moving contract manufacturers of getting these whole sales channels integrated so they worked with Mark Wallace Broader channel and we're very pleased with where that is right now. Our funnel is very strong. And we did see an increase in the actual conversion rate of our funnel from Q2 to Q3. And we're expecting that to continue and to improve more, but I'll let Mark make a couple of more comments.

Sure. Thanks Ron. Hi, Rick. Ron covered a lot of it. We've made great progress since we spoke last in the business and optimizing our whole sales operational process. We were very pleased with the increase in the funnel conversion during Q3, and we expect to see that continue even further in Q4. We had some really important wins. One of which was mentioned in the prepared statements with NTT DOCOMO. We introduced some new products around 400 gigabit Ethernet test, which -- one of which we won Best in Show at Interop in Tokyo. And our funnel is stronger than it's been in many, many quarters. So the outlook is good. We continue to see strong demand for 400g, like the wireless business 5G is a big opportunity for us in the future. And again, I'm very excited about where we are with the optimization of our integration and sales and the very healthy funnel as we go into Q4.

Okay. Does volume play a role -- this might be some of the things value sound like a funny question, but will volume play a role as you move forward in this margin? Because I know we have worked to do on the margin line, but I'm wondering how much of that work that we need to do yet is around cost and efficiency versus this peer volume?

Peer volume, you're exactly right Rick is really the issue. If you take a look at this, we've had very high gross margins, and we have fixed amount of expenses. So once we start ramping the revenue, the fixed expenses will stay relatively fixed. And you'll be able to see that flow through right to the bottom line and get great incrementals.

Okay. And just as a follow-up. Ron, could you, perhaps, maybe just size on an annualized basis, maybe the software business. And I'm curious with the growth we've seen in that business. Is that being pulled along or driven by 5G or automotive or any particular vertical?

Well, there is no doubt that software is used more and more in many of the applications that we address. We got ahead and we acquire signals, but then you have to analyze them. And now with our most recent oscilloscope that we have launched, we literally make a trillion measurements per second or we sample at a trillion measurements a second or 256 billion precision measurements a second tons for channels. So as that data comes off, software is the only way to analyze that. We do some of that software within chips or in firmware or in pure software. But if I take a look at the overall business, in FY'17, it was over $500 million in software. Now as we look in this year, this quarter we're running, obviously, significantly above that. And that's even without Ixia. And when we add Ixia software in and we're going to be doing -- adding that to our total number, but we just want to make sure that we breakout the products that are -- let's say, half hardware and half software and do that correctly. You'll see that number go up and up. But there is no doubt 5G drives software as well as many of our other applications. That business is growing and we like that not only for increased margins, but we also like that for potential recurring revenue for the long term.

And your next question comes from the line of Brandon Couillard with Jefferies. Your line is now open.

Just a couple of follow-ups, Neil, the service margins were down little bit year-over-year despite the top line growth, are you making some specific investments there around capabilities, anything color you can share with us?

You know, as we've discussed about this business in the past, our original thought was we're going to be able to make some significant acquisitions, smaller ones, but a number of them in this business to increase the growth rate. We have sense pivoted to a more organic growth strategy, which does require investment. You're starting to see that hit the top line over the past several quarters, and we are confident in our ability to increase the profitability in this business. So likely into the -- to the upper teens is where we think it ultimately settles. It will likely have a profit level that is below the company average, but certainly in that upper teen ranges where we would expect it to settle.

And then secondly on the China aerospace and defense headwind, you mentioned of the $10 million to $15 million a quarter. Just sure speak to how you arrived at that number and your confidence levels visibility around that headwind and potential that it could be worse or perhaps not actually as bad as you expect right now?

Well, obviously, the China situation is changing every day. And so we have pretty good visibility into our end customers and have an open dialogue with them on a regular basis. And from working with our management team, we're able to assess what some of those pressures are that we're seeing in the market. I'll let Mark see if he has any additional comments, but that's how we sized it at the moment. We're monitoring it constantly. And we'll see how things evolve as we move forward.

Yes, this is Mark. The only thing I'd add to that is as the team is monitoring the situation with the trade tensions, we're obviously also paying close attention to all of our customers, and I can tell you that the overall tone remains positive. We're working with all of our customers, if anything; they're interested in working further with us. And as I mentioned before, our business is very broad in China with 5G, automotive, semiconductor and aerospace defense. So we're looking at both sides of the equation and so far the effects not wide reaching.

We've also gone down and looked at something which China calls or the U.S. government calls the restricted party list companies that you're not allowed to sell through, and we comb through that list. We know exactly what's in the funnel, what customers buy. So any changes that have occurred in the U.S. policy on where we can sell, we've already quantified that and included that in that overall number.

Thank you. That concludes our question and answer session for today. I would like to turn the conference back to Jason Kary, for any closing remarks.

Thank you, Krista, and we appreciate all of you joining us today. We look forward to seeing many of you at the upcoming conferences. And with that, we'll close and have a great day.

This concludes our conference call. You may now disconnect.