Keysight - Earnings Call - Q2 2020
May 26, 2020
Transcript
Speaker 0
Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Second Quarter twenty twenty Earnings Conference Call. My name is Robert, and I will be your lead operator for today. After the presentation, we will conduct a question and answer session. Please note today's conference is being recorded today, Tuesday, 05/26/2020 at 01:30PM Pacific Time. I would now like to hand the conference over to Jason Carey, Vice President, Treasurer and Investor Relations.
Please go ahead, Mr. Carey.
Speaker 1
Thank you, and welcome, everyone, to Keysight's second quarter earnings conference call for fiscal year twenty twenty. Joining me are Ron Nercesian, Keysight's Chairman, President and CEO and Neil Dougherty, Keysight's Senior Vice President and CFO. Joining
Speaker 2
us
Speaker 1
in the Q and A session will be Mark Wallace, Senior Vice President of Worldwide Sales and Satish Dhunashakaran, President of the Communications Solutions Group. You can find the press release and information 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. 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 reference to core growth, which excludes the impact of currency movements and acquisitions or divestitures completed within the last twelve 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 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. Lastly, I would note that management is scheduled to participate in upcoming virtual investor conferences in June hosted by Baird, Bank of America and Stifel. And now I will turn the call over to Ron.
Speaker 3
Thank you, Jason, and thank you all for joining us. First and foremost, we hope that you're all staying safe and well, and our thoughts are with everyone affected by the coronavirus pandemic. The world has faced unprecedented challenges over the past several months and I would like to thank all of our employees for their continued dedication and commitment to Keysight, our customers and our our partners. Our execution and results this quarter underscore the power of our balance sheet, business model and our Keysight leadership model, which drives our unique high performance culture and guides our company to continuously delivering greater value to customers, shareholders and employees. I'll focus my formal comments today on three key headlines for the quarter.
First, the health and safety of our employees is our top priority. After acting quickly to temporary close most of our global locations in mid March and implementing risk mitigation measures in response to the pandemic, we are now re opening sites and our production capacity is ramping rapidly. Second, despite the mandatory government shutdown of our production facilities and resulting supply disruption impact on our Q2 revenue, Keysight delivered steady orders, strong operating margin and record free cash flow. Our results demonstrated the exceptional resilience of our business and the durability of our financial operating model. And third, despite the near term uncertainty, we are confident in our differentiated market leadership position, the strength of our operating model and the long term secular growth trends across our diverse set of end markets.
Turning to the dynamics that impacted second quarter results, demand was steady across markets in February. As the impact of the pandemic expanded beyond China in early March, we responded quickly to limit the spread of the coronavirus and mitigate the risk to employees, customers and suppliers while also responding to local government directives. On March 18, we issued a press release to announce the temporary closure of most locations around the world, including our production and order fulfillment facilities, which were fully closed for two weeks in March and had limited activity in April. We also took the necessary steps to deliver on our customer commitments, particularly those that provide essential services and support the communities in which we operate around world. Working with local governments and health officials to implement health and safety measures at all of our locations, we are pleased to announce that we are reopening sites worldwide.
Despite ongoing broader industry supply chain challenges, we are ramping our Keysight production and services operation and expect to be back to 100% capacity by the end of the third quarter. Now let's take a deeper look into our financial results. Order growth was positive through March followed by a decline in April to finish the quarter down only 3% compared to last year's record second quarter. While we don't typically comment on calendar quarter performance, given the dynamic nature of the situation, it's worth noting that Keysight's orders and revenues both grew mid single digits in the January through March timeframe. Despite lower than expected revenue as a result of supply chain disruptions, the resilience of Keysight's business model was exceptional and our flexible cost structure performed as expected.
As a result of our immediate actions to reduce costs and preserve liquidity, we delivered operating margin of 19%, record free cash flow of $275,000,000 and a record cash balance of $1,800,000,000 Our second quarter revenue declined 18% year over year as both segments of the business were impacted by the limited manufacturing capacity. However, we continue to see steady demand across several end markets with ongoing investment in next generation technologies such as five gs, 400 gig and advanced semiconductor node processes. Other markets such as general electronics and automotive are expected to be more challenged in the near term. In commercial communications, our ongoing five gs order momentum resulted in a new record. Our end to end solutions portfolio continues to gain strong global customer adoption and is enabling the commercial five gs launches underway.
We are further solidifying our global leadership position across both the wireless and wired five gs ecosystem through close collaborations with market leaders, leadership and standards and first to market five gs design and test solutions. This quarter we introduced Keysight's new five gs core network test solution called LoadCore. The five gs core testing software simulates complex real world subscriber models. This enables mobile operators and network equipment manufacturers to qualify performance and reliability of voice and data transferred over five gs networks. This solution leverages from the Ixia and Prisma acquisitions to deliver testing capability needed by our customers.
We also announced a collaboration with Rakuten, an operator in Japan to enable their five gs deployments using solutions for test, validation and optimization of devices and networks. Keysight comprehensive solutions portfolio spanning the entire ecosystem is a key differentiator in the market. In aerospace defense and government, order growth was driven by strong demand in The U. S, which was partially offset by lower international investment. Our solutions for electromagnetic spectrum operations, radar, space and satellite continue benefit from a favorable U.
S. Spending environment and ongoing investments in technology modernization. Despite the substantial challenges in the automotive sector, next generation electric is a strategic priority for our customers. Keysight continues to invest to be first to market with solutions and remains highly engaged with key market players. For example, we recently announced the use of our Cyanlab battery test solution in the BMW Group's new battery cell competence center in Germany.
Foundry customers are continuing to prioritize investment in advanced process node technologies and incremental infrastructure. This resulted in revenue growth for our semiconductor measurement solutions where we had less supply chain disruption. Software and services continue to contribute to the differentiation of our solutions and recurring revenue base. While growing above the company average over time, they are strengthening the durability and diversity of our business model. In Q2, the combination of both software and services represented approximately 35% of revenue.
Turning back to the current COVID-nineteen pandemic, we are committed to supporting our customers and our communities through this challenge. For our customers, we launched an Innovate Anywhere program to enable IT teams to support remote users ensuring VPN performance and security. We also implemented various health and safety measures at our facilities to ensure all safeguards are met before production and other operations resume. For our communities, we are contributing to the relief efforts globally through monetary and supply donations. These include donations of personal protective equipment to local hospitals and government agencies providing support to children, families and the most vulnerable.
We are also making contributions to local communities and global nonprofit organizations. Before turning the call over to Neil, I'll close with a few key points. Keysight is a market leader in large diverse growing end markets and serves a diversified global base of over 32,000 customers across multiple industries. The challenges of this pandemic are unprecedented and I'm proud on how our team has responded. Our execution demonstrates the durability of our business and the resilience of our business model with 19% operating margin and solid cash flow even with a Q2 revenue impact.
We continue our significant investment in R and D and remain focused on first to market solutions. Our sales teams remain highly engaged with our customers and we continue to execute our strategy for long term term above market growth. While we expect ongoing COVID-nineteen demand and supply chain headwinds over the next few quarters, our long term secular market growth trends and the strength of our operating model remain intact. Expect to come through this challenge stronger than ever. Now I will turn it over to Neil to discuss our financial performance and the outlook in more detail.
Thank you, Ron,
Speaker 4
and hello, everyone. Before I get started, I will note that all comparisons are on a year over year basis unless specifically noted otherwise. Keysight delivered a solid quarter, thanks to strong execution in a challenging environment. While supply chain disruptions dampened our revenue performance during the second half of results demonstrated the resiliency of our operating model and durable cash generation. We responded quickly with proactive measures to reduce costs and preserve liquidity while supporting our customers and advancing key projects.
For the 2020, we delivered revenue of $895,000,000 down 18% on a reported and core basis due to our site closures and supply chain disruptions that started in mid March and continued through the end of the quarter. Orders of $1,100,000,000 were down 3% on a reported and core basis. As Ron mentioned, we continue to see steady demand in investment across multiple end markets, particularly for our next generation communications solutions. Turning to our operational results for Q2. We reported gross margin of 63%, with improved mix and lower spending partially offsetting the impact of lower revenue.
The flexibility of our cost structure resulted in lower variable compensation and a reduction in outsourced manufacturing costs. This, combined with other specific actions, such as a temporary hiring freeze and reductions in discretionary spending, enabled our flexible operating model to perform as expected, resulting in 19% operating margin for the quarter. Net income in the second quarter was $148,000,000 On a per share basis, we delivered $0.78 in earnings. Our weighted average share count for was 189,000,000 shares. Regarding performance of our segments.
In light of the broad supply chain disruptions, CSG and EISG expense management and margin performance were exceptional. CSG operating margin was 18%, while EISG delivered 24% operating margin. On the demand side, general electronics, education and automotive were weak, while investment continued in five gs, aerospace defense and other leading edge technology solutions. Moving to the balance sheet and cash flow. We ended our second quarter with a record $1,800,000,000 in cash and cash equivalents with $450,000,000 of additional liquidity available under our undrawn revolving credit facility.
We reported cash flow from operations of $298,000,000 and record free cash flow of $275,000,000 or 31 percent of revenue. The strength of our cash generation reflects the power of our financial operating model, which incorporates a flexible cost structure and includes a financial playbook that is designed to preserve margins and cash generation during challenging times. Under our share repurchase authorization, we acquired approximately 1,300,000 shares on the open market in the first half of the quarter at an average price of $91.14 for a total consideration of $120,000,000 Our year to date repurchases are sufficient to achieve our objective of being anti dilutive for the full year and to exit the year at 190,000,000 shares. While we are focused optimizing liquidity, given our strong operating model and cash generation, our capital allocation priorities remain unchanged. Now turning to our outlook and guidance.
While we are not quite back to full capacity, our production operations and those of our suppliers have been ramping since mid April. We expect to make continued progress in Q3 and as a result expect third quarter revenue, operating margin and earnings to be in line with or better than Q2. These expectations are based on our order funnel, a strong backlog position and assume limited incremental supply chain constraints or disruption from additional shutdowns or a second wave of the pandemic. While maintaining R and D investments for the future growth, we will continue to focus on profitability and leverage the flexibility of our operating model to manage expenses. In closing, the near term situation is obviously challenging, but we remain focused on our long term strategy of enabling our customers' success leading edge solutions.
Once the COVID-nineteen situation stabilizes, the durability of our business model, cash generation, strong balance sheet and market leadership position give us confidence in our long term financial targets that we shared you at our Investor Day in early March, specifically sustainable long term core growth of 4% to 6%, operating margin of 26% to 27% and EPS growth of at least 10% over the long term. With that, I will now turn it back to Jason for the Q and A.
Speaker 1
Thank you, Neil. Robert, will you please give the instructions for the Q and A?
Speaker 0
Certainly. Your first question comes from the line of Mehdi Hosseini with Susquehanna. Please go ahead. Your line is open.
Speaker 5
Yes, sir. Thanks for taking my question. I want to go back to your reported backlog. Despite the shortfall in revenues, you were still able to grow backlog by double digit. And given your assumption for booking for the current July, do you expect a resumption of year over year growth in quarterly revenue by the October?
And I have a follow-up.
Speaker 3
Thanks. Yes, this is Ron. Our backlog our book to bill was 1.22 for the quarter, showing very strong backlog build. And obviously our profitability, our operating model was strong and held up at 19%. If we had shipped that, we clearly would have been in very strong shape with operating margin in the mid-20s.
As far as the quarter going forward, we have seen our operations turn on. Our main international operations that we have in Penang, Malaysia is back to 100% capacity. The main operations that we have in The U. S. Are at about 70% capacity and will be at 100% by the end of the quarter.
So even though there is a short term disruption to the end of to the second half of Q2 and the first half of Q3, we expect Q3 revenue to be at about the same level. We don't guide for orders for the future quarter though.
Speaker 5
Okay. Perhaps maybe I could rephrase the question a different way. I'm assuming that the strength in your communication group is driven by orders for millimeter wave on R and D and also you highlighted 400 gig networking. As R and D activity on the wave picks up, is there any synergy between that and the networking that would enable you with a bigger size of the customer wallet? In other words, the seven stack approach that you have focused on, would that finally become becoming material so that you could capture a bigger part of the customer?
And is that what's going to be driving the momentum with booking for small growth areas.
Speaker 3
Yes, we've had a we had a strong quarter in five gs. We had a very strong quarter in 400 gig back into the network. And our overall play of winning up and down the ecosystem does create that synergy. I'm going to let Satish talk a little bit about the details.
Speaker 6
Yes. Thanks, Ron. Mandy, you're correct in that communications especially these new areas such as five gs with millimeter wave adoption and 400 gig and such are really gaining increased importance in today's world given what we have seen in terms of a disruption. So that should start to manifest itself. In fact with discussions with customers we're having today, the focus is on accelerating innovation and going faster.
So that positions us well having the entire Layer one to Layer seven capabilities internal to the company and having built that platform I referenced at the Investor Day gives us an advantage to go faster and deploy solutions with customers. You will also note that we have a number of industry leading collaborations that we announced just this quarter with the likes of Qualcomm, Rakuten, China Unicom, Sonic and others that spans the wireless to wireline arenas and positions us well for the future.
Speaker 5
So does that mean that the synergies are beginning to materialize?
Speaker 6
Yes, think so. And you'll start to see them accelerate as we launch more solutions. We have some 90 new solutions planned for the second half of the year, which we're investing for and that should continue to position us very well in the communication space.
Speaker 5
Thank you.
Speaker 0
Your next question comes from the line of Tim Long with Barclays. Please go ahead. Your line is open.
Speaker 7
Thank you. I just wanted to ask about the China market. Could you talk a little bit about the trends there? Obviously, timing for manufacturing and businesses opening was a little bit different. So and obviously, some more political talk there.
So can you just give us an update how China was and how you're viewing that the next few quarters? And then I had a follow-up.
Speaker 8
Tim, this is Mark Wallace. I'll take that question talking about China. The main headline from Q2 is that our business remained steady. We had a stronger February than we expected coming out of the Lunar New Year that, as you recall, was extended by an extra week. And we saw strengths continuing in five gs and commercial comms as Satish talked about both at the physical layer and across the protocol stack, 400 gigabit R and D and optical manufacturing continued to ramp as we saw global demand come from the carriers and the data centers.
Automotive was down and we saw some mixed conditions in general electronics and education as we made comments in the opening remarks. And China continues to accelerate investments in semiconductor capability, particularly around next generation semiconductor technology. And as you alluded to, there's a continuing set of evolving U. S. Regulations.
We're paying very close attention to these. At this point, there might be some indirect impact to some of the foundry business. We're not really able to quantify that just yet. We have assessed the overall situation in terms of the most recent U. S.
DOC restrictions and regulations, and we believe it represents something on the order of one to two points of headwind going forward. But as we did with the August 2018 RPL additions, we will redirect sales resources to go after new opportunities to drive growth elsewhere. And all of these restrictions, go across all of our technology companies that supply into China, not just Keysight. So the bottom line I would say with China is our customer engagements remained high during the quarter as we adapted to the new remote environment that we're now leveraging across other geographies and our business in China remained steady despite all of these challenges and headwinds.
Speaker 7
Okay. Thank you. And then just as a follow-up, I think you mentioned 35% of revenues coming from software and service in the quarter. Could you talk a little bit about the ramp there? Do you think are you hearing from customers with the kind of global disruption like this that there might be more of an accelerated move to those type of models?
You.
Speaker 8
Yes, Tim, this is Mark again. I'll take that. Regarding software and services, as you point out, we saw revenue growth in the quarter faster than the rest of Keysight as has been the case for many quarters. Revenue for software was roughly flat, services was up slightly on a core basis. We had a record high Q2 for our design software orders, which indicates the continued demand from customers who continue to work remotely, during the global pandemic.
And as Ron mentioned, in his opening comments, we introduced the Innovate Anywhere initiative, which was very successful, really enabling thousands of software engineers to work from home. And, you know, moving forward, we see this program feeding into the superior software and services growth that we've been delivering for a long time. Our customers, and their engineering workflow has changed, and we expect to see customers continuing to work in this mixed, lab and work from home environment. And I think our software and services provides us another way to support their engineering teams, in either case to maintain engineering productivity. So, yeah, we do see our software strengths continuing to be a factor, especially in the new go forward environment that we're experiencing.
Speaker 7
Okay. Thank you.
Speaker 0
Your next question comes from the line of John Marchetti with Stifel. Please go ahead. Your line is open.
Speaker 9
Thanks very much. Ron, I was wondering if you could comment a little bit on the demand side as you've gone through these last couple of months. You mentioned obviously that January through March both orders and revenue were growing in the mid single digits. But I'm just curious, with orders down 3% year over year for the quarter, did you have customer behavior change dramatically in that month of April as well that coincide with your ability to ship? How has this sort of disrupted your customer landscape, not just your own supply side issues?
Speaker 3
Sure. Obviously, we had a drop off in April when everything pretty much shut down. So our order level was lower. Our sales organization worked from home and actually has been very effective after the first couple of weeks just trying to figure out how to contact customers. A matter of fact, they've been finding it pretty efficient to be able to get on with Zoom as long as they have an established relationship with those customers.
But that's what we saw with regards to the seasonality in the quarter. Revenue, we've talked about that and how that is ramping now and we'll be back to full strength by the end of the quarter. Mark, would you like to add anything? Yes. What I would
Speaker 8
add is, we did see customers working hard from home. They were actually more accessible than they normally would be because we knew where to find them. So we engaged with them. We continue to book business and we continue to build our funnel for Q3 and beyond. It's at the highest level really it's ever been looking out three months.
But there was some pullback in certain areas. As an example, some of our general electronics business is tied to new engineers being hired. Right? And obviously, that wasn't going on. Some of the government funded activities such as research, obviously, our education business based on universities being closed, were affected, and we saw that effect happen more toward the end of the quarter.
So there's some there's some, you know, dynamics from the industry that that really played in that timing as well.
Speaker 9
Great. And then maybe just as a follow-up to that, was there a big difference that you saw geographically? Obviously, we all know that China has kind of come back from this a little bit more quickly than some other areas just given that that's where everything started. But as you look out across North America and Europe, have there been, I guess, big regional differences as you've seen those demand trends play out?
Speaker 8
Yes, John, what I would say is there was some regional differences mainly from kind of the distribution of different segments and different customer behaviors. As an example, we already talked about the fact that we saw strong order growth in The U. S. From aerospace defense that continued throughout the quarter from both the direct government and the prime contractors. Whereas in Europe, the strength was really more around semiconductor solutions, tied to advanced technologies like EUV, which is extreme ultraviolet lithography and some next generation processes.
And then, you know, we saw some growth in commercial comms in Europe tied to some new five gs design wins. And, you know, so it varied. What I would say is is most regions saw the impact when it came to kind of the general electronics and automotive segments. So so there's some there's some variety from region to region based on different industry dynamics in each of the regions.
Speaker 2
Thank you.
Speaker 3
It is interesting, John, it is interesting to note though that a lot of our major customers have said they're not slipping schedules and they're doing everything they can to either stay on track or make up for any type of shortfall that they have. And that bodes well for some type of, let's say, accelerated purchasing at some point when they do need it.
Speaker 9
So as we get back to a more normal environment, you would expect that you'll be able to at least sort of make up some of this shortfall here in this fiscal 2Q and 3Q?
Speaker 3
Yes. And clearly with the backlog, you could see we built $200,000,000 worth of backlog in the last quarter. There's no doubt that we will be able to clear that out at some point in the future. We've guided or given you a range for Q3 where we expect to be. But beyond that, we expect ourselves to be at 100% and we'll be ramping rapidly from there.
Speaker 8
Rob, only other add I'd add for John just real quick. We look at cancellations, we didn't see any increase in cancellations. We look at is there any kind of push outs to Ron's point about projects staying on track. We really didn't see a lot of push outs either. So we built a strong funnel and I think we're going to be in a good position when the economy begins to recover.
Speaker 3
And the good news is the global race continues to be ahead in five gs, which nobody wants to take a pause.
Speaker 9
Thank you for the color.
Speaker 0
Your next question comes from the line of Toshiya Hari with Goldman Sachs. Your line is open.
Speaker 10
Good afternoon, guys, and thanks very much for taking the question. Ron, you talked about record five gs bookings in the quarter. I was hoping you could elaborate a little bit more on that in terms of the composition of those orders between R and D test and production test? And if you can kind of speak to the individual customer groups like the chip guys and the base station customers, the mobile smartphone customers that would be helpful? And then I've got a quick follow-up.
Speaker 3
Sure, Toshiya. I'll let Satish who's right in the middle of it give you more of the details.
Speaker 6
Yes, Toshiya, it's a very strong order quarter for five gs. Our orders grew at record levels as mentioned before in Ron's comments. But equally worth noting was the strength continued into April and the growth that we saw was broad. It was across all regions grew and all segments of the customer base grew all the ones that you referenced chipsets, devices and the NEMs and even the operator segments. I would say if we fill back the types of applications sustained investments in R and D, manufacturing started to ramp.
In fact, we had a good uptake for our modular offerings, which were enabling some of the component manufacturers to ramp up. So that was a positive note for us. And then we also saw success in new verticals such as automotive with the CV2X application that we just launched and with our aerospace and defense solution with some of the five gs security offerings we have launched. So in summary, some of the opportunity progression that I had outlined at Investor Day started to play out in Q2. And we also added 40 new customers for our five gs platform through our marketing efforts and working with our sales teams globally.
I also want to say that our customer engagement through this phase has been very strong even though some of our customers are working from home. They have been continually engaged as Rod mentioned to make sure that their projects don't slip too much. And in some cases where they're slipping, they're looking at ways to accelerate. I also want to highlight some of our, let's say remote working with customers is working very well. In fact, our five gs virtual events have been well attended by over 8,000 customers.
So that points to the strength of our solutions there.
Speaker 10
Got it. Very helpful. And then as a quick follow-up, you spoke about some of the near term headwinds related to automotive, general electronics, education and government. Curious what percentage of your overall business do those end markets collectively account for? And is it fair to say fundamentals, whether it be bookings or revenue troughs in the April?
Or could there be continued weakness into July? And as a follow-up to that, if you can kind of speak to your exposure to Huawei and the foundries in the semiconductor business that would be very helpful. Thank you.
Speaker 4
Yes, we haven't sized those specific markets, Toshiya, but the GE and automotive markets are a significant portion, more than half of obviously, the part that's missing there is a semi business, which has been strong. EISG's business is kind of more heavily or more the weaker market areas are more heavily weighted towards EISG with general electronics, automotive, EISG, these things that tend to be more tightly linked to
Speaker 11
GDP.
Speaker 3
The auto business in particular has slowed down. We obviously saw significant slowdowns as everybody has seen in the industries for the old technologies or old auto. Some of the new auto wasn't as strong as it was pre COVID, but we still feel very good about our position. So we are there for when that market snaps back.
Speaker 4
your second part of your question as it relates to Huawei, we don't really have any change at this point as it relates to our expectations of Huawei going forward. We kind of still would expect them to be a 1% to 2% customer for us on a go forward basis.
Speaker 11
Thank you. You.
Speaker 3
Your
Speaker 0
next question comes from the line of Jon Pitzer with Credit Suisse. Your line is open.
Speaker 2
Yes, Ron, Neal. Thanks for letting me ask the question. Ron, I was just wondering if you could help us understand what you think the supply impact was for COVID in the quarter. And I guess in your prepared comments, you said it was both a production and an order fulfillment hit. So I'd be kind of curious as to how much revenue and orders do you think you lost in the quarter from the supply side of COVID?
Speaker 4
Yes. I mean, it's impossible for us to know what would have happened, right? But I think if you go back to where we were at the beginning of the quarter, we obviously put a guide out for the quarter that we had a high degree of confidence in our ability to hit. And so you can look at that delta relative to our guidance on the revenue line. And for all intents and purposes, I would attribute that shortfall to COVID.
I think from our perspective, the world changed in mid March as we talked about the sites being closed, limited productivity in April, but we continue to be very optimistic about how we're positioned on a go forward basis. We're a leader in our markets. We have a strong technology position. And I think as markets recover, we're going to come through this even stronger.
Speaker 2
And just to be clear I'm sorry, go ahead.
Speaker 3
Yeah, think it is fair to say taking a look at our order rate and knowing how we do our supply chain planning, a book to bill of around one was probably would have been normal if there wasn't a COVID issue for Q2.
Speaker 2
That's helpful. And then guys I know you're not giving official guidance for the July, but I'm just kind of curious from a production perspective. If you look at the April relative to 100%, where were you for the blended average of the quarter? And as you look into July, I know there's a lot of moving parts, how do you think sort of relative to 100% your production levels look in July versus April?
Speaker 3
Well, you could go back and look
Speaker 4
at history of where we've been operating somewhere around the $1,100,000,000 per quarter kind range is close to full production. So that gives you an idea of something to key off of. Obviously, the dynamic is a little bit different, right? We were going full steam ahead through mid March, and then it shut off pretty quickly with a ramp in April. We're now continuing to ramp in May, expecting to be back to something close to 100% across ecosystem by the end of the quarter.
So you kind of have to ramp down last quarter followed by the ramp up this quarter. And as close as we can call it at this point, the revenue numbers and profitability numbers are going to be in the same vicinity as one another.
Speaker 3
So if you look at that, you could see where we were down roughly a couple $100,000,000. We're down at roughly 80% of capacity. So the fact that we took out, we lost a couple of weeks in March and then you could take another week or two out of April just as you start to see that ramp or ramp linearly. So that's a very rough estimate, but I think it's pretty accurate.
Speaker 2
And Ron, if I could just sneak one last one in. Just given your production issues, can you talk a little bit about your share position? And is there any concern that competitors might be able to take this opportunity to steal some share on the margin?
Speaker 3
I don't think so. There could have been there can be some very minor issues. But if I take a look at orders and I look at orders January, February and March, we grew mid single digits on the order line, which is pretty competitive. Nobody else or very few people have reported in our industry what happened in April. So when they come out, I'd be surprised that their numbers were not the same.
We've been growing above market every single quarter now for years. And for everything that was going on, I do anticipate that we are at market or better. And our backlog position now is so strong. You'll see that flow into revenue and profitability and cash flow as we go forward.
Speaker 10
Very helpful. Thank you.
Speaker 3
Thank you.
Speaker 0
Your next question comes from the line of Adam Thalhimer with Thompson Davis. I
Speaker 12
wanted to try to understand the margin disparity in Q2 just because the EISG margins held up so much better. And is that a trend you expect to continue?
Speaker 4
Yes. So I mean if across you our business, right, the one area where we saw actual revenue growth was in semi, which is all within EISG and it's also a very high margin segment for us. So I think you're predominantly looking at a mix issue or not issue, a mix benefit that EISG received with the very strong semi shipments relative to the other parts of their business. And so that's really what you see going on there.
Speaker 5
Okay.
Speaker 3
And it's worthwhile to note that obviously with a lot of fixed infrastructure as we start to see business come back, you'll continue to see very strong gross margin performance.
Speaker 12
Okay. And then so high level, it sounds like you're kind of girding for a more protracted downturn at EISG. But at communications, it sounds like when the COVID situation allows, you'll kind of quickly turn back to revenue growth. Is that fair?
Speaker 4
Yes. I think EISG has businesses that are more GDP linked. We talked about General Electronics, which includes the Education segment. But if we just talk about Education for a while, until there's really two aspects of Education. There's the teaching aspect and the research aspect.
But in both cases, you need students on campus, right, to really get those education markets up and going. Automotive, we know what's happening in the auto industry. So we still don't know what the shape of the recovery is going to look like. You can read all the same reports that I read about what the ultimate recovery is looking like. But EISG, I think, tends to be more macro linked and more linked to GDP linked or GDP where the drivers within CSG, the rollout of five gs, the rollout of 400 gigabit, the aerospace defense investments potentially have the ability to buck some of those trends as folks work to get those technologies to market.
Speaker 11
Okay. Thanks.
Speaker 0
Your next question comes from the line of Jim Suva with Citigroup. Your line is open.
Speaker 13
Thank you. And I have two good evening. I have two questions. I'll ask them both at the same time, so you can answer them in any order and they're pretty straightforward. The first is with coronavirus, is the r and d cycle still lengthening or are people now adjusted to work from home and work remotely now where it's actually compressing?
The reason why I ask is it seems like two months ago, it was everything progressing slower. And now it sounds like from your comments and other companies' comments, things are kind of coming back. So I was kind of wondering about the design cycle. And then my second question is, your inventory went up quite a bit, but you talked about supply chain issues. Was that simply not having all the right parts to put together your heavy equipment and your big calibration items and your test and measurement things?
Or did some of your inventory like trapped in certain locations or you're missing just a couple of widgets that go into it and so you're like 98% of the box completed before you can ship? Thank you.
Speaker 3
Sure. Jim, this is Ron.
Speaker 5
I'll just take the questions. I'll take
Speaker 3
them in reverse order. With regards to the inventory situation, it's real simple. We have parts coming in the door and we have no one in the factory to build them. And that's the case that we had in the March. It's not the case now as we have Penang up and running, but we also supply parts from our tech center in The United States.
So when there's nobody putting together parts or even if things are put together and they're not shipped, there's no revenue credit. So all parts have to be there in order to complete a product. There are thousands of parts in certain products, some made within Keysight and more of the commodity type pieces that are put into products in addition to our unique differentiators. Some of them flow in and some flow out. But the bottom line was we weren't putting together any systems or shipping them out.
And that was because of not only internal to the Keysight manufacturing facilities, but also the contract manufacturers that would do subassemblies. But now we're very happy with the progress that has been made and where we are now and where we expect to be by the end of this quarter. The second issue with regard to the R and D cycle, there was a bit of a stop, but everyone was trying to figure out how to operate in this new normal where every customer that we spoke to or very, very high percentage of them went through that. Now they've situated to work at home, to go in part time, to use test systems or in some cases like China return back to work. So we see the R and D engineers being much more efficient.
And accordingly, they're trying to figure out how to keep their projects on track because they are competing against their ultimate competition. So that's why we see things accelerating in that cycle. How much equipment acceleration we'll see at what rate is yet to be seen. But we feel very positive as we look forward.
Speaker 13
Thank you so much for your details and clarifications. Greatly appreciate it.
Speaker 11
Thanks, Jim. Your
Speaker 0
next question comes from the line of Richard Eastman from Robert Baird. Your line is open.
Speaker 14
Hi. Just a few questions or two questions. One just kind of targeted at Aerospace and Defense. And just a couple of thoughts here. What was the order growth in A and D year over year?
And then secondly, was the with A and D, was the business and the revenue there disproportionately impacted by the plant shutdowns? Because it wasn't a very tough comp, and I'm just curious with the revenue down 25%, if there was a disproportionate impact there?
Speaker 4
Yes. So I'll take that. We from the order perspective, orders were basically stable versus last year. With regard to the revenue impact, some of that stuff, particularly for The U. S.
Markets required to be built in The U. S. We did get earlier access to our Penang facilities than we did to some of our locations in The U. S. And so there probably was I think it is fair to say that there was a disproportionate impact on aerospace defense from a manufacturing perspective, just given the fact that the access to The U.
S. Facilities lagged the access to our facilities in Asia in April.
Speaker 14
I got you. And then just a follow-up question around the backlog. One would expect perhaps that given access just globally is better to customers as hopefully they everybody starts to return to work here. We got some of the access kinks maybe worked out a little bit in the fiscal second quarter. But typically your orders are flat to a bit softer in the third quarter relative to the second.
But again with improvements around access, would you expect to build backlog again in the third quarter given where you are and the disconnect between the production ramp and kind of what's going on the order and sales side?
Speaker 3
We don't guide orders out for Q3, Rick. I think as you know, but we're going to try to do everything we can to lower our backlog. I'm not saying that we've guided that, but what we're trying to do is approve our position to get our deliveries out to the customers that need them. You're right on a typical non COVID environment, we see a ramp at the end of Q2 and then the biggest ramp at the end of Q4, which is literally how we do the comp in the field organization. And then Q3 is not as high as you would expect when looking at Q2.
But overall, we expect orders to be very solid and not out of line with what we've seen in the past.
Speaker 4
Yes. I mean, obviously, the COVID situation is going to supersede the normal seasonality of the business. From a Q2 perspective, we had the first half of the quarter, which was I don't want to say unimpacted, but through the first half of our quarter, this was essentially still viewed as largely China problem. It didn't go global until mid March in the second part of the quarter. I think the macro side of things is where it is now.
We don't know where it's headed. But so I think you're going to see a different seasonality than is as typical. And then I like Ron's way of characterizing it. I mean, I think we've guided revenue in Q3 in line with Q2. We're certainly pushing on the manufacturing side as hard as we can push it.
But right now, the way we see it and way we see the ramp progressing, you're going be looking at revenues that are more or less in line.
Speaker 3
And the reason why you see that isn't so much the internal capacity. You could do the math and say for 100% right now internationally in Penang and we're at 70% in The U. S. And you do some type of linear extrapolation of basically the facility that we have in our fab in The U. S, you could come up with a much higher number.
But in order to produce products, need three things. You need all the parts, you need your contract manufacturers for sub assemblies and you need the key site manufacturing facilities. The CMs are very close to 100%. UCR facilities getting close to 100%. But we still are relying on the delivery of components from different suppliers that go into our products.
And that is something that is a bit extended that is figured into our guide.
Speaker 14
I see. Okay. Okay. And can I just putting that all together, just tying it together, Neil, if we're looking at a similar cadence of revenue monthly through the fiscal third quarter, We've got the issues that you've spoken to around production, production ramp, overhead? Is there any reason to assume the decremental for the third quarter won't be similar to the second quarter given the flexibility in the model?
Speaker 4
I expect it to be similar.
Speaker 14
I got you. Thanks for the short answer to a long question. Thank you.
Speaker 0
Your next question comes from the line of David Ridley Lane with Bank of America. Your line is open.
Speaker 15
Sure. Good afternoon. So China's stimulus package included $30,000,000,000 or so earmarked for data centers. And in The U. S.
And Europe, the work from home trend has shown some of the weaknesses that are out there in corporate data centers and networks. How do you think about Keysight and their ability to benefit on a relative basis from those trends?
Speaker 3
Satish owns the data center portion and we'll let him answer.
Speaker 6
Yes, I think we think with the upgrades to data center technology and in lieu of what people have learned from working at home and at the scale is definitely going to be a positive driver for us especially for our Ixia business with multiple implications. Speed is one of them. Security is one of them and visibility being the other piece to it. Right now, we did have a strong double digit quarter for 400 gig based on some ramps we're seeing in China and our outlook for that part of the business continues to be favorable.
Speaker 15
Got it. And then a question, could you maybe quantify the cost savings actions that you took and if there are some that are structural in nature, could you maybe call that out? Thank you.
Speaker 4
Yes. We're very pleased with the way our operating model has performed. We've talked a lot about what we felt we could do in a down cycle. The business the model has a number of structural elements that are designed to respond instantaneously to changes in condition. The number one of those is the variable pay component.
Again, 100% of our employees have a portion of their pay that fluctuates with our business results. Outside of the executives, the rank and file, if you will, that's really tied to our growth rate and to our operating margins. And so as both of those things corrected in the third quarter, we saw a significant reduction in our people related costs, similarly with contract manufacturing, outsourced sales, those types of things, those came online. Beyond that, we took action to reduce discretionary spend, everything from again, certain things happen relatively automatically like travel basically crashed towards zero in the second half of the quarter, reductions in temporary workers. The executives we have actually put in a pay cut for our executive team ranging from 100 percent at the CEO level to 50% for the senior vice presidents.
So we've taken a number of different actions to further reduce spending.
Speaker 15
All right. Thank you very much.
Speaker 0
Your next question comes from the line of Brandon Couillard with Jefferies. Your line is open.
Speaker 9
Hey, thanks. Good afternoon.
Speaker 16
Ron, just a quick one for you. Now that you're back to
Speaker 9
the net cash position, I'm
Speaker 16
what you might be seeing in terms of the M and A funnel and if the dislocation in the market has perhaps created some incremental opportunities for you to take a look at here?
Speaker 3
Yes. Well, Brendan, we have the same priorities that we had before obviously to fund organic growth to make sure that we stay neutral or anti dilutive and to look at M and A opportunities. In certain cases, things have become more attractive, but we still have our high hurdle to beat our cost of capital with our return on with our excuse me, to beat our WACC with our ROIC. And we continue to look pretty aggressively at those. But again, we will make sure that the ROIC is high enough.
Speaker 16
Thanks. And a quick one for Neil. Just on the CapEx line for the year, you're still thinking about $120,000,000 for the year. Is that still a firm number? Or do expect some of those projects to maybe get pushed out kind of like
Speaker 4
every time? Yes. No, we'll probably push out a little bit. Obviously, we've made significant capital commitments already for the year, but we will we would expect to understand. We're probably now looking at something more like 100,000,000 to $110,000,000 for the year.
Speaker 16
Very good. Thank you.
Speaker 0
Your next question comes from the line of Samik Chatterjee with JPMorgan. Your line is open.
Speaker 11
Hi. Thanks for taking my question. I just wanted to start off with more a question on the manufacturing footprint here. I mean, we've seen a lot of companies face supply chain headwinds this quarter, but your magnitude of the shortfall has been obviously larger given your kind of concentration in U. S.
And Malaysia. Just wanted to get your thoughts about whether you're thinking any differently about the long term plans relative to the manufacturing footprint, anything to mitigate that risk? Obviously, I understand it's a once in a lifetime thing, but how are you thinking about it in the long term about where you want to be?
Speaker 3
To have a global pandemic come and literally be ordered out of our own factories is something that we don't think is typical. And I don't know if it's once in a lifetime, but it's a very rare occasion. We also have a lot of our manufacturing capacity that are spread around with CMs and the CMs are located in different countries where they can move their production from one facility to another and move
Speaker 1
it
Speaker 3
around into different countries. So we look at that. We review that annually and make sure that we have an optimized footprint trying to balance what we typically would see and what type of benefit there is financially versus spreading out over multiple factories. So we continue to do that analysis. We have the discussions all the time.
And there are some things that we do, do that we're not always public.
Speaker 11
Just a follow-up, and I know you've commented quite a bit on the call here about kind of strength in the auto trends you're seeing. Just wanted to kind of see if you can help us match that up relative to kind of how you expect some of the customers that you're interacting with to respond if the macro remains quite weak going into the second half. Obviously, auto trends here are strong, but the expectation, I think, remains from the customers that macro will hold up quite well. What do you think in terms of where do you expect to see some incremental weakness? Or which customers or projects do you expect to be more fungible relative to if we have a weaker macro in the back half
Speaker 5
of the year? Thank you.
Speaker 3
I think the country by country race to lead in five gs will continue regardless of the macro situation. There is too much at stake for a lot of our large customers and you know them from the NEMs right through the whole ecosystem and communications. And they will continue to drive towards getting to market first. When you look at the GDP plus or the GDP or GDP plus businesses such as general electronics and the general manufacturing there, could see a slowdown as we've seen for instance in automotive. So I think those are the businesses that will continue to see some weaknesses, which are automotive and general electronics.
But I do expect the communications business where there's a race for that to be robust going forward. And as you know, that's the strongest part of the business and that enabled us to produce 19% operating margin.
Speaker 11
Thank you. Thank you.
Speaker 0
You. That concludes our question and answer session for today. I'd now like to turn the conference back over to Jason Carey for any closing comments.
Speaker 1
Thank you, Robert, and thanks, everyone, for joining us today. We look forward to hopefully speaking with many of you at the upcoming virtual conferences that we mentioned, and wish you all a good day.
Speaker 0
This concludes our conference call. You may now disconnect.