Keysight - Earnings Call - Q4 2020
November 18, 2020
Transcript
Speaker 0
Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Fourth Quarter twenty twenty Earnings Conference Call. My name is Chris, and I'll be your lead operator today. After the presentation, we will conduct a question and answer session. Please note that this call is being recorded today, Wednesday, 11/18/2020 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, Carey.
Speaker 1
Thank you, and welcome everyone to Keysight's fourth quarter earnings conference call for fiscal year twenty twenty. Joining me are Ron Nercesian, Keysight's Chairman, President and CEO and Neil Dougherty, our CFO. Joining us in the Q and A session will be Satish Dhanushakaran, who was recently appointed our Chief Operating Officer and Mark Wallace, Senior Vice President of Worldwide Sales. 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'll find an investor presentation along with Keysight 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 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 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. Lastly, I would note that management is scheduled to participate in upcoming virtual investor conferences in December hosted by Credit Suisse, Wells Fargo, Barclays and Cowen.
And now I will turn the call over to Ron.
Speaker 2
Thank you, Jason, and thank you all for joining us. Keysight delivered an outstanding quarter to finish our fiscal year, driven by strong execution and broad based demand for our differentiated solutions. Despite COVID related macro challenges, it was a record year for orders, gross margin, operating margin, earnings per share and free cash flow. Today, I'll focus my comments on three key headlines. First, we delivered exceptional fourth quarter results driven by strong execution as demand for Keysight's next generation technology solutions continued and end market demand began to recover.
Second, record profitability and cash flow again demonstrated the durability and strength of our financial operating model despite a challenging macroeconomic environment. And third, our long term outlook for revenue and earnings growth is strong, and we haven't wavered from our pre COVID long term financial commitments and growth expectations announced in March. The power of Keysight's leadership model and our execution this year underscore our ability to deliver on these commitments, which includes 4% to 6% long term core revenue growth and achieving 26% to 27% sustainable annual operating margin by no later than fiscal year twenty twenty three. Now let's take a deeper look at the strength of our fourth quarter and fiscal year twenty twenty financial performance. In the fourth quarter, broad based demand for Keysight Solutions drove strong results across the business as the economic recovery in certain sectors gained momentum.
Record orders of $1,200,000,000 exceeded revenue and grew 3% year over year and 15% sequentially. We achieved fourth quarter revenue growth of 9% year over year with growth across all regions. Both the communications and electronic industrial solutions groups achieved record revenue in the quarter. The resilience of our financial operating model resulted in an all time high profitability and cash flow. In Q4, we delivered gross margin of 66% and operating margin of 29% and earnings of $1.62 per share and free cash flow of $3.00 $8,000,000 For the year and despite COVID related macro challenges and supply chain disruption, orders grew to 4,500,000,000.0 an all time high for Keysight.
As you recall, in Q2, we responded to government directors to limit the spread of coronavirus and closed the majority of our offices worldwide, including our order fulfillment and manufacturing operations. We then ramped back up our production capacity in Q3. Despite the significant disruption, full year revenue of $4,200,000,000 declined only 2% year over year. Even in a difficult operating environment, we continue to deliver on our margin expansion commitments. Both gross margin and operating margin improved by over 100 basis points, generating a record $4.85 per share in earnings in fiscal year twenty twenty.
Turning to our markets. The Communication Solutions Group record quarterly revenue was driven by growth across the aerospace, defense and government and commercial communications. Aerospace, defense and government revenue increased 13% year over year in Q4, driven by strength in The Americas and Asia as defense modernization continues to drive investments in technology with the focus on electromagnetic spectrum operations, space and new commercial technologies like five gs. In commercial communications, five gs technology is scaling and drove strong demand across the design life cycle from development to deployment. Keysight has the industry's most comprehensive range of five g design and test solutions, enabling the global build out of networks and devices.
Five g has been a strong growth driver for us for over the past three years, and we continue to see new use cases and ongoing innovation as the ecosystem scales and adapts to a new technology. A recent example of our five g solutions approach includes collaboration on ORAN with many industry leaders. Investment continues across the commercial communications market spanning wireless and wired technologies in data centers and also in the cloud. This quarter, we announced a new high performance PXIe modular five g base station solution. It is enabling network equipment manufacturers and small cell vendors to accelerate their time to market.
This solution also incorporates enhancements from our PathWave software platform that help automate some of the current workflow limitations. Within the Electronic Industrial Solutions Group, orders and revenue for our broad portfolio of general electronic solutions both grew double digit, driven by gradual economic recovery across most regions and improvement in the education market. Demand for our semiconductor measurement solutions was again strong this quarter as investment in next generation process technologies continued. In automotive, while macro driven weakness continues to weigh on the sector, strategic investment in the advanced automotive technology is a market priority. We saw improvement from last quarter as orders grew double digit sequentially across all regions.
Our Scion Lab electric vehicle test solutions are expanding in Asia and Europe where government mandates are driving the electrification of vehicles. We continue to add to our solutions portfolio, addressing challenges in the development of advanced driver assistance systems or ADAS and ensuring compliance to important standards. In Q4, we introduced a new radar target simulator for ADAS being developed to enable autonomous driving as well as a new solution for testing automotive Ethernet standards compliance for in vehicle networks. We also recently announced collaborations with SGS and Qualcomm to advance testing of cellular vehicle to everything or CV two x technology. Turning to software and services, combined, they were one third of total Keysight revenue for this year after another quarter of solid growth.
In addition, recurring revenue increased from 18% of total in FY 2019 to 21% in FY 2020. On an annualized basis, recurring revenue grew high teens over last Software and services are important elements of our solution centric strategy and differentiation and further strengthen the durability of our business model. In Q4, we launched new and enhanced solutions to tap the power of cloud based processing and advanced analytics to speed design simulation, validation, and manufacturing test. These include several new PathWave software solutions targeting advanced design, compliance test, automation, and measurement and manufacturing analytics. Increasingly complex designs and the volume of data associated with their validation are driving demand for Keysight solutions.
Keysight's execution and financial performance this year is a testament to Keysight's leadership model, our values, and our commitment to corporate social responsibility. A year ago, I shared with our teams my top priorities for the company. One of these priorities was a specific focus on increasing our inclusion and diversity efforts. In support of this priority, I appointed a new senior director of inclusion and diversity who has been working with key site leaders and external organizations to increase representation of diverse groups within our workforce. We place a high value on inclusion and diversity at all levels of our organization, including the Board of Directors.
We continue to make progress, and I'm pleased to share that as of today, over 30% of our US executives are diverse in gender, race, and or ethnicity. Before I turn the call over to Neil, I'd like to sincerely thank all of our Keysight employees for their relentless commitment, engagement, and dedication to our success over the past year. Our people and culture are truly a competitive differentiator. Thanks to their efforts and in the face of unprecedented challenges, Keysight exits this year stronger than ever and is very well positioned to capitalize on our growth opportunities ahead. Now I will turn it over to Neil to discuss our financial performance and outlook in more detail.
Speaker 3
Thank you, Ron, and hello, everyone. Before I begin, please note that all comparisons are on a year over year basis unless specifically noted otherwise. As Ron mentioned, we delivered an outstanding quarter and despite a challenging macro environment, we continue to make great progress towards our long term annual financial targets. In the 2020, we delivered record revenue of $1,220,000,000 dollars which was above the high end of our guidance range and grew 9% or 7% on a core basis. Q4 revenue growth was driven by continued demand in areas such as five gs, semiconductor measurement and aerospace defense where we have leading positions and differentiated solutions.
Demand for general electronics improved significantly in the quarter driven by regional economic recovery, particularly in Asia. Total Keysight orders exceeded revenue in Q4 with a book to bill just over one. We delivered a record $1,231,000,000 dollars in orders, up 3% or 1% on a core basis. Looking at our operational results for Q4, we reported gross margin of 66% and operating expenses of $446,000,000 resulting in operating margin of 29%, an all time quarterly high. Net income was a record $3.00 $5,000,000 and we achieved $1.62 in earnings per share, which was well above the high end of our guidance and an increase of 22% year over year.
Our weighted average share count for the quarter was 188,000,000 shares. Moving to the performance of our segments. Our Communication Solutions Group generated record revenue of $9.00 $1,000,000 up 8% while delivering record gross margin of 66% and record operating margin of 29%. In Q4, Commercial Communications generated revenue of $6.00 $5,000,000 up 5% driven by strength across the five gs ecosystem from development to early manufacturing, Gen5 high speed digital applications and data center related 400 gigabit and 800 gigabit technology. Aerospace, defense and government achieved record revenue of $296,000,000 an increase of 13% versus a prior all time high in Q4 last year.
Growth was driven by strength in The Americas and Asia with improvement in Europe. The Electronic Industrial Solutions Group generated fourth quarter revenue of $319,000,000 up 12% or 7% on a core basis driven by strength in general electronics and semiconductor. EISG reported gross margin of 65%, an increase of two thirty basis points year over year and record operating margin of 30%. Given the challenges that we faced this year, we are very pleased with our full year results. FY20 revenue totaled $4,200,000,000 down 2% year over year or 3% on a core basis impacted by supply chain disruptions and macro challenges caused by the pandemic.
Despite this small revenue decline, gross margin improved 140 basis points year over year to 65. While continuing to invest in R and D at 16% of revenue or nearly $700,000,000 for the year, operating margin improved 130 basis points to 25%. This year over year improvement demonstrates strong progress towards our annual operating margin target of 26% to 27% which we expect to achieve by fiscal twenty twenty three. FY20 non GAAP net income was $919,000,000 or $4.85 per share for the full year. Moving to the balance sheet and cash flow, we ended our fourth quarter with $1,800,000,000 in cash and cash equivalents and reported cash flow from operations of $338,000,000 and record free cash flow of $3.00 $8,000,000 Free cash flow is net of a $100,000,000 funding contribution to our U.
Pension plan in the quarter which provides a tax benefit in the current year and a pension expense benefit in FY21. Total free cash flow for the year was $899,000,000 representing 21% of revenue and 98% of non GAAP net income. Under our prior share repurchase authorization, we were opportunistic in deploying capital during the quarter. We acquired approximately 2,200,000.0 shares on the open market at at an average price of $96.55 for a total consideration of $215,000,000 and exhausting our $500,000,000 share repurchase authorization from May 2019. This brings our total share repurchases for the year to approximately 4,300,000.0 shares at an average share price of $95.9 for a total consideration of $410,000,000 or 46% of free cash flow.
As announced earlier today, the Keysight Board of Directors has approved a new share repurchase authorization of $750,000,000 effective immediately. Before moving to FY 'twenty one modeling and our Q1 guidance, I'd like to provide a brief update on global trade concerns. We admittedly have a tough order comp in Q1 due to China trade restrictions and the pending U. S. Administration change which has historically dampened government business during the transition.
Despite these headwinds, we have started to see gradual improvements in many of our markets and are entering the year in a strong backlog position giving us confidence in our ability to navigate these near term perturbations. Looking to FY21, we expect quarterly revenue seasonality to be more muted than in the past due to ongoing COVID-nineteen and macro related uncertainty. Just as we flexed expenses down this spending and variable compensation is expected to increase in FY21 to more normal levels with Q2 expenses seasonally higher than all other quarters. In addition, FY21 pension expenses reflected in the other expense line are expected to increase by $5,000,000 per quarter. Interest expense is expected to be approximately $78,000,000 and capital spending is expected to be in the range of $170,000,000 to $180,000,000 as we begin a two year project to increase the resiliency of our supply chain.
Regarding our tax rate, we are modeling a 12% non GAAP effective tax rate for FY21. Now turning to our outlook and guidance. We expect first quarter twenty twenty one revenue to be in the range of $1,140,000,000 dollars to $1,160,000,000 dollars and Q1 earnings per share to be in the range of $1.32 to $1.38 based on a weighted diluted share count of approximately 188,000,000 shares. In closing, our solid outlook for revenue and earnings growth coupled with the durability of our business model give us confidence in our ability to deliver on the long term financial commitments we outlined in March prior to COVID. Despite the challenges of this past year, we continue to make good progress towards our long term targets of 4% to 6% core revenue growth and the annual operating margin of 26% to 27%.
With that, I will now turn it back to Jason for the Q and A.
Speaker 1
Thank you, Neil. Chris, will you please give the instructions for the Q and A?
Speaker 0
Your line is open.
Speaker 4
Yes. Thanks for taking my question. I wanna go back to your booking and better understand specific to commercial communication, how should I think about orders for five g, specifically millimeter wave? And how does the networking, like a fiber for 800 gig compared to millimeter wave related orders? And I have a follow-up.
Speaker 5
Yeah. Thanks, Mehdi. This is Satish. I'll take it. You know, our commercial communications, group had a record revenue this quarter and second consecutive quarter of sequential improvement.
And a large part of the results were driven by strengths in both the wireless and wireline ecosystems, specifically from a trend perspective, five gs and 400 gig were big drivers of growth for us. And I would say in five gs, while we observed three things, right? The commercialization is ramping. A large part of that is low frequency or mid band frequency networks. The standardization of the technology continues to progress.
And the big theme is the ecosystem is expanding. So these are sort of three big trends that are enabling both wireless and wireline technologies to be strong for us. As far as the millimeter wave is concerned, we view the we have long viewed and we continue to view the millimeter wave opportunity as very favorable for us because of the upgrade, upgrade potential, it represents and our traditional strengths in millimeter wave technologies play out. And, even, this quarter, specifically, we continue to see a steady ramp in customer interest as they retool their engineering flow to adopt to the millimeter wave technology. On the wireline side, we captured pretty strong ramps that occurred for 400 gig in Asia throughout the year, and we are starting to see increased activity in r and d to our 400 gig and 800 gig Ethernet this quarter.
Speaker 4
Okay. Just a quick follow-up. And as we look into FY twenty one, five g goes into production, how should I think about the software content? And this question actually ties into the last question. As we go into production, should we expect continued strength in r and d, r and d that is soft and heavy?
And in that context, would the gross margin hold up? Or as we go into production five g, should we expect some gross margin headwind? Thank you.
Speaker 5
Yes, Mandy. As far as R and D, we continue to see robust pipeline for demand for R and D with Release 16 features coming out next year. So I would continue to see strength there. With regard to our production test opportunities, we're starting to see that the deployments are actually driving ramps in the supply chain and we're benefiting from them. And in fact, this quarter, we referenced a pretty sizable win for our PXIe or release of our PXIe modular solution, which has also has software content associated with it.
So we'll continue to
Speaker 3
see a steady improvement there as well. Yes. I'd certainly expect any margin impact from a migration towards manufacturing to be more or less undetectable at the Keysight level when you think about $4,500,000,000 of revenue and the progress we're making generally as a company around software and services and other areas. So not something we're concerned about.
Speaker 4
Thank you. Our next question
Speaker 0
is from Samik Chatterjee with JPMorgan. Your line is open.
Speaker 6
Hi. Good afternoon. Thanks for taking the question. If I can just start off with Commercial Communications as well and just following up on Satish's commentary here on five gs momentum being strong. Just wanted to see if you can outline how to think about maybe kind of an acceleration in terms of five gs revenue momentum?
And how does that play into kind of what kind of declines to expect on the four gs revenue side? Any thoughts as we look into kind of the next of years on that front? And I think one of your competitors has also talked about some of the five gs release delays driving order weakness. So have you seen anything on that front?
Speaker 5
Yeah. There is no doubt that the there has been some implementation delays in some quarters of the ecosystem. If if it were not for this, you know, given given the momentum that the industry is sustaining, we would be further along. Having said that, we saw strong orders for our business the quarter and for the full year in five gs. And we see a robust pipeline for Release 16 in R and D and for production related expansions that customers are planning for.
So we continue to believe that five gs represents a long term opportunity for us, especially as we have talked about our portfolio being broad, starting with the physical layer where we have millimeter wave, bulk of the millimeter wave opportunity in front of us. And then we have the protocol layer where Release 16 and Release 17 to follow where there has been some delays in Release 17 that you referenced. But Release 16 is a very high impact in terms of its expansion into new use cases that we're very excited about. And lastly, I would say that we saw strong growth in the application layer opportunity where we've expanded our five gs strength even beyond commercial comms into aerospace and defense with security applications, into our general electronics business to multiple industries and into automotive with CV2X. So you piece that all together, continue to believe that this is still very early innings in five gs as we said at Investor Day.
Speaker 6
So Nishu, if I can just follow-up, what are you seeing in terms of activity on the four gs side? Are we at a point where some of these revenue declines moderate on the four gs side?
Speaker 5
Yes. I think, we've obviously, the year over year, if you looked at last year, we saw some expansions in traditional smartphone driving up the legacy of four gs business. And so comparatively, things declined sharper this year, given that customers prioritize five gs. But again, I would go back to saying we have a very broad breadth of tools for the labs that we offer. And in many cases, customers delayed that spend, and we expect that to stabilize and ramp back up as customers return and recover from COVID.
Speaker 6
Thank you. Thank you for taking my questions.
Speaker 0
Our next question is from Tim Long with Barclays. Your line is open.
Speaker 7
Thank you. Just if I could just follow-up with one on the five gs side, then ask on optical. Just talk a little bit about kind of the pricing and competitive environment as some of the competitors try to play a little catch up there. Any changes of note? And then secondly, you mentioned some strength in the data center, 400 gig, 800 gig.
Could you expand on that a little bit? Where do you think we are in that cycle? And if you could also talk into the service provider opportunities as they transition to six hundred and eight hundred gig as well? Thank you.
Speaker 5
Yeah. Thanks. I I think our differentiations front, I would say, continues to be strong. You look at the standards based test cases, that we offer, and you can see that we're leading and we're staying on the cutting edge and that's what our customers appreciate. So on the edges, we don't see any material change to our competitive position with regard to these advanced technologies, and we have continued to invest this year in R and D to keep our differentiation strong.
So that's the point I'll make. With regard to how this is all playing out, you might say, if you just think of the smartphone use case, there is about 7,200 band combinations in five g that have been defined. And to date, only 1,500 of them are being tested. So the latest devices that we have, account for 1,500. So you start to see that there is considerable runway just in the smartphone use case.
And with Release 16, that is in front of us, there is new expansion opportunities for industrial applications and automotive applications that creates a healthy pipeline, for us. With regard to the wireline, the first phase of the 400 gig deployments have largely been in what I would consider East West traffic that flows in a data center. And with more to come as operators start to deploy this technology when price on the transceivers start to become more affordable. So that's the second wave we expect. But there is continued evolutions of 400 gig and 800 gig that have started, which feeds into our R and D strength.
Thank you.
Speaker 0
Our next question is from John Pitzer with Credit Suisse. Your line is open.
Speaker 8
Yes. Good afternoon, guys. Congratulations on the solid results. Couple of questions. Just when we think about the year over year compares on both revenue and orders to the fiscal first quarter guidance, can you just remind us how much of a headwind Huawei should represent fiscal first quarter to fiscal first quarter?
And sticking on the China topic, I'm just kind of curious, when you think about the five gs strength, how important has China been over the last several quarters? More importantly, as you look into the first half of the year, you know, what are you expecting from China? I guess the underlying question is, do you feel as though China will continue to deploy five gs at a relatively healthy clip despite the Huawei ban? And do you think there's some potential for digestion there before reacceleration?
Speaker 5
Yeah. So this is Neil. Why don't
Speaker 2
I take the first part
Speaker 3
of that and then maybe we'll have Mark comment on on on China and some of our expectations there. Think the most important comment with regard to Huawei is the situation with Huawei is not gonna change, you know, our expectations as it relates to our long long term growth outlooks for our business or for our for our for our markets. Right? We're entering the year in a very strong backlog position, and I think that that strong backlog position is gonna enable us to essentially mitigate the impact of any short term perturbations that may happen on the order line because of the year over year Huawei compares. We have an extraordinarily diverse base of customers around the world that's driving demand in our end markets, And, and and we're looking at that and and the the strengthening we've seen over the past couple of quarters, you know, relative to where we were in q two, and and and we're gonna keep our foot on the gas relative to those long term targets.
Speaker 2
Yes, John, this is Mark. I'll follow-up with that. So the business our orders in China in Q4 were strong and steady throughout the quarter despite some decline, obviously, impact from Huawei that came from strengths in five gs and it is extending across the ecosystem as we scale those solutions. As Satish talked about 400 gig is hot, high speed digital and optical manufacturing. So it's a very broad industry for us.
We've also, seen the economic recovery in China. They recovered first and more quickly, and we've seen that show up in our automotive order growth and general electronics. And the bottom line is, as Neil mentioned, our business in China is we have a very broad footprint. The business is strong. We've been successful and will continue to be successful to deploy and redeploy our resources, to continue to capture growth in five gs and across the other segments.
Speaker 8
Thanks, guys. Very helpful.
Speaker 0
Our next question is from Matt McMahon with Deutsche Bank. Your line is open.
Speaker 9
Hey, guys. Thank you for taking the questions. One on margins. So you're exiting the year a lot closer, and I think actually exceeding your sort of longer term target. And so maybe, Neil, if you can help us think through why with a seemingly improving you've got a big backlog, revenue trajectory should improve.
The anticipation of margins maybe reverting back lower. How how we should sort of think about, the different puts and takes? And then just one follow-up on orders. I know normalized order growth was about 1%, and you're sort of reaffirming the sort of longer term top line growth targets of four to 6%. Just wondering if you can sort of call out the bigger areas that are still lagging and the path to get back to that sort of longer term mid singles growth rate.
Thanks.
Speaker 5
Yeah. So let me start
Speaker 3
with the margin side of that first. So first of all, we're very pleased with the margin performance of the business in the year. And we look at, you know, this year and some of the challenges of this year as a great test of the operating model that we've been talking about really since the launch of the company. That being said, our operating margin targets, our margin targets in general, they're annual targets, not quarterly targets. We hit 25% this year, and we've talked about getting to 26% or 27% operating margin, is the target that we outlined at our Analyst Day, and we're still working towards that objective.
I think we're highly confident in our ability to achieve that. And as we look forward to this year, I think you can look to, you know, obviously in the second and third quarters, you know, with revenue down and and the corresponding expenses down, but you saw in q four the kind of margin performance that we can put up with expenses turning to or returning to a more normalized level. With regard to with regard to kinda how we get back to to mid single digits, you know, I think we are seeing some, you know, relative strengthening across the the broader markets and of economies in general. I think we you know, a a great indicator of that is what we're seeing in general electronics. You know, we saw a strong return under education business, which is as I think is indicative of of of some recovery from the COVID situation.
Even looking at businesses like auto, you know, while while auto orders were still down on a year over year basis, we saw very strong sequential improvement in auto. So so so things are getting better, and and I I think we're gonna look, really across, you know, across the entire portfolio for strength and just broad macro strengthening to help drive us to those levels.
Speaker 6
Thank you.
Speaker 0
Our next question is from Chris Snyder with UBS. Your line is open.
Speaker 10
Thank you. You guys talked about the tough q one comp. Can you just maybe, tell us what percent of FQ1 orders and revenue came from Huawei just to give us a feel for what
Speaker 3
the underlying demand is? We we expect it to be about a five point headwind in the in the first half. You know, that's that's roughly how we're thinking about it. But again, I think given the backlog situation that we have coming into the year, I think that's going to be the dominant driver of our business. I think that's going to give us the ability to and give us some time to overcome what might be some short term perturbations on the order line.
We're highly confident going into the year.
Speaker 10
Okay. Appreciate that. And, I mean, is it fair to assume that you 5% for the first half, it's it's more weighted, into fiscal q one, just kinda given that, you know, the China COVID impact hit in the fiscal q two?
Speaker 3
No. That's correct. And I I said I said as much in in our in my prepared remarks. We we clearly have a tough order comp in q one, but I'd point you back to the backlog situation. We're guiding strong revenue growth in the first quarter, and we're going to be in a good position as we migrate through the year.
Certainly, revenue comps in Q2 and Q3 get significantly softer, obviously, but the backlog that we built over the last several quarters is going to provide a buffering for us.
Speaker 10
Appreciate that. Then just kind of following up on that, some peers have talked about the ability to sell non U. S. IP to Huawei. Can you maybe talk about any opportunity here for Keysight?
And have these restrictions that we've seen led to any upstream share shifts that will maybe allow you guys to partially offset this headwind as we move into 2021?
Speaker 3
Let me take the first part of that, and I'll let Satish maybe comment on the second part. We do have some ability to sell some small portions of our portfolio into Huawei going forward that don't include any material US technology, but it is a a very small portion of the portfolio. We do not expect Huawei to be a material customer for us going forward.
Speaker 5
And and just to add, to what Neil said, you know, it's too too soon to call any share shifts, but we start to see the smartphone Tier two smartphone makers in China continue to invest in R and D because they see an opportunity. So that's probably one positive offset, if you will. The second one that is evolving is the resurgent interest in open RAN technology to sort of provide a different alternative to base stations, to five gs base stations. I think you look at those two things have the potential to for us in the, you know, as we look into 2021 and beyond.
Speaker 10
Thank you for the time. Appreciate it.
Speaker 0
Our next question is from Adam Thalhman with Thompson Davis. Your line is open.
Speaker 7
Hey, good afternoon, Great quarter. Have like 15 questions that I can only ask one.
Speaker 3
Make it a
Speaker 7
good Let's go with the seasonality for fiscal year 2021, Neil. I think you said less seasonality in 2021. I'm just curious what you meant by that and how you want us to model it.
Speaker 3
Yeah. We we just we just think, again, I I'm gonna bring you back to the backlog situation as we slowly work off the backlog that we built up over the last several quarters. We think that is going to essentially mute the impact of what would typically be more demand driven quarterly seasonality that we've seen in prior years. We expect a much more muted revenue seasonality over the coming quarters, maybe with a slight uptick in Q4, but much more muted revenue seasonality than is typical.
Speaker 7
Got it. Thank you, guys.
Speaker 0
The next question is from David Ridley Lane with Bank of America. Your line is open.
Speaker 11
Sure. Thank you for taking my question. I'm just wondering what the kind of all in temporary cost reductions were in fiscal year twenty twenty to come back in fiscal year twenty twenty one. Just trying to get a sense of, as you referenced in your prepared remarks, some of those variable costs flexing back up.
Speaker 3
Yeah. I mean, think that, you know, the big drivers, obviously, we we we've talked at length in prior quarters about our variable pay programs and the flexibility of cost model. You know, that's probably the single biggest driver. Then there's the obvious things that, that, you know, impacted many companies, you know, dramatic reductions in travel as an example. I would point you to kind of our Q4 expenses.
I think we largely saw our spending return to more normalized levels here in the fourth quarter of the year. Obviously, we'll continue to do some of the administration and other things. I think as we look forward, you could look to Q4 as a baseline. And then as we said in the prepared remarks, we do expect Q2 to be higher than the other quarters from an OpEx standpoint in FY 'twenty one.
Speaker 11
Got it. Thank you very much.
Speaker 0
Next question is from Richard Eastman with Baird. Your line is open.
Speaker 12
Yes. Thank you. Thanks for the question. Neil, could you just give us the backlog number at the end of the year? I mean, at face value, it looks like it's up 22%.
But I'm curious, maybe, was there any debooking of orders around Huawei or anything on the defense side? Or did we enter with that kind of a step up?
Speaker 3
We we have not seen any material and and and any change in in kind of de booking. There's always some noise level, you know, level of de bookings, but that hasn't changed at all. Obviously, we built a significant amount of backlog just looking at the difference between orders and revenue for the year. It's on the order of $300,000,000 of which a portion of which you would consider to be kind of abnormal backlog build revenue given disruptions or the shipment disruptions in the second and third quarter. So it's that abnormal portion of backlog build that we'll be looking to work off over the course of the next several quarters.
Speaker 12
Okay. Okay. And then just a question around Ixia. Can you give us a sense of are you seeing any uptick in demand there? Just given the timing and the pacing of demand relative to the new network rollouts and infrastructure rollouts, but how does Ixia look here at the end of the year and for the year?
And does the outlook look like from a demand standpoint for 2021?
Speaker 5
Yes, Rick. So it's been a little over a year since we integrated the Ixia business into the commercial communications segment, and we've made some excellent progress in realizing synergies with respect to solutions. I would say in the networking space, we see a 400 gig Ethernet. Our portfolio has been significantly strengthened, not only in the physical layer, but also in the protocol layer with the addition of the ICS Layer two, Layer three business. And we're securing some good wins in the industry as the R and D investment flows.
And with the security piece of the business that we acquired, now we're able to integrate that with our five gs platform and realize greater synergies there as we position solutions for the aerospace and defense industry. So that's another area where not only are we addressing traditional opportunities, but also some expansion areas. With five gs now getting deployed, we're starting to see pickup in demand for the visibility part of the business where we just this quarter, we had a couple of big opportunities that we closed on with operators looking for enhanced application layer visibility there. So overall, I would say, you look at the big trends of virtualization, cloud and the progression that's going into the application layer, we view the portfolio to be strong and we think the outlook is favorable. Obviously, right now, everybody is recovering from COVID, so that sort of gates that recovery.
Speaker 12
Okay. All right. Thank you and congrats on a very solid quarter, nice quarter. Thank you.
Speaker 2
Rick, this is Ron. Just one other comment. We talked about the backlog build in FY 2020. You may want to also go back and look at the log build in FY 'nineteen because it's been a very steady build that we've had for many quarters beyond FY 'twenty.
Speaker 12
Got you. Okay. We'll do that. Thank you.
Speaker 0
Next question is from Jim Zuva with Citigroup Investment Research. Your line is open.
Speaker 11
Thank you very much. A question on the backlog. I heard you mentioned several times that it's strong and then you just have a clarification that it built in fiscal twenty nineteen as well as fiscal twenty twenty. So the question is, are you at a point where the backlog is now this most recent quarter that we use reported starting to work down? Or was it still growing?
And the duration of work down, is it kind of two or three quarters? But you just said in fiscal twenty nineteen, it was building also. So I'm just trying to figure out the dynamics of the variable of the backlog.
Speaker 5
Yes. So obviously, Jim, we've been
Speaker 3
a growing business here for a number of years. And so we you know, it's not we would expect that our backlog would be growing in absolute terms just given the the overall growth of the business. I think if you look, what you saw in Q4 was a, you know, pretty much a reduction in rate of growth of that backlog, right? We built very significant backlog in Q2 and Q3, as I previously referenced, kind of abnormal levels of backlog because shipments were depressed because of the factory shutdown and re ramp. In Q3, while our book to bill was over one, it was just a tick over one, right?
So we were more or less in a neutral position in fourth quarter. And so, you know, as I think about going into next year, we have this, you know, backlog that is I particularly focused on kind of abnormal amount of backlog build where we've where we've got to get, where we've got to get product delivered to customers. And I think on a positive note, you know, really, when we were in the process of building that backlog in q two and q three while orders remained strong, because our customers' businesses were disrupted, we weren't in a situation where they were really pounding on the door saying, in most cases, we need immediate delivery of this product. And we really saw that tick up in the fourth quarter, which is what drove the revenues north of $1,200,000,000 I think it's that dynamic of our customers now looking to take delivery of that backlog that was built in the Q2, Q3 timeframe that is going to be the predominant driver of revenue for the next couple of quarters.
Speaker 11
Just housekeeping for the stock buyback, is it meant to just keep share count relatively flat and offset dilution? Or is it actually meant to bring the share count down? Well, I'd say a couple
Speaker 3
of things about that. So first of all, obviously, we've made a commitment to at least at a minimum be anti dilutive with our buyback programs, and we will continue to do that. But just as you saw with us in Q4 and frankly over the course of FY20, we will be opportunistic when those windows approach, right? And so we were very pleased to take 4,300,000.0 shares off the market at an average price somewhere around $96 this year, bringing the share count down. And so when we see those windows, we'll certainly do that.
But at a bare minimum, you can count on us to keep the share count content constant. We did say in our prepared remarks that we expect to in FY 'twenty one our share count to be 188,000,000 shares, which is flat. So that's our base case for modeling. When I think about priorities for capital beyond share repurchase, we continue to have an active M and A funnel development process. We continue to look for ways to put money to work through M and A and assets that are accretive to growth, accretive to gross margin, much like the acquisition that we did of Eggplant at the end of last quarter.
So no real change for our capital allocation priorities at this point in time.
Speaker 11
Thank you so much for the details and clarifications and good results. Thank you. Thank you.
Speaker 0
Our next question is from John Marketti with Stifel. Your line is open.
Speaker 11
Thanks very much. I wanted to ask a quick question on the semiconductor business. That's been strong now for a few quarters. I'm just curious to get your view of where we are in that process node transition cycle. And as we're looking out into 'twenty one, how we should think about that semi business performing for you as we're going into next year?
Speaker 5
Yes. I'll make some comments, and maybe Mark can also chime in on the forward looking demand. I would say that we had a very strong year for the semi business, and it's been driven by the growth in the five gs devices and the high performance computing needs that proliferated, especially due to folks working remotely and working from home environment. And we've also captured and capitalized on the China IC spend. Our position in that in the semi business is highly differentiated.
We continue to track the node sizes from seven to five, and now a new a new activity starting for three nanometer. So we're highly differentiated there. And, and I'll hand it off to Mark to make some comments on forward looking demand.
Speaker 2
Yes. What I would add is that the leading demand, as Satish talked about, is continuing. And the length of the process of retooling the fabs is a very long one. So we're involved in relatively long sales cycles that involve both the process nodes and new technologies like with extreme ultraviolet lithography. And we see those opportunities continuing to drive into next year.
We see continued investments in China as well as other parts around the world, including The United States with the chips program that was announced, several months ago. So the bottom line is, you know, we we could see some market constraints coming in in the next couple of quarters, but we see continuing demand for our process solutions, to support these next generation technologies.
Speaker 11
Great. And then maybe, Neil, just a quick follow-up on the gross margin strength here. You know, how much of that, I guess, is mix related? Is it a a function of that continuing growth in the, you know, the recurring software piece of the business? You know, as we look out into next year, I guess, what's the right sort of level setting for that given some of the strength we've seen, you know, even with some of the challenges that you had through through this fiscal year?
Speaker 3
Sorry. Let me repeat that because I realized my mic was off. We continue to be very pleased with the progress we're making on gross margin. And really, there's a lot that goes into that. First of all, I'd start with software content, right?
During this year, our software business continued to grow, outgrow the broader company. And so we continue to see nice growth software, and we continue to make great progress in the conversion of the way our customers buy software from us towards more time based, time based, know, purchasing. So we've actually saw our annualized recurring revenue grow in the high teens during FY20, so that's helpful. We're making great progress. I talked about this last quarter in our services margin portfolio.
That's a below average gross margin business for us. But on the operating line, we have our services business now north of 20%, which has been a long term goal, and a lot of that improvement has come on the gross margin line. And then I would talk about our migration towards selling Complete Solutions the entire portfolio, right? As we migrate to those Complete Solutions, they tend to be more highly differentiated, and we can monetize that differentiation. And so, you know, you couple that with the strength that we're see the strengthening we're seeing in the markets over the last couple of quarters.
I mean, I think we're we're very pleased with the way, you know, you know, the the strength of orders really through the entire cycle of this year, but but the strengthening in q four, the broad, the, you know, the broad indications of macro recovery across large portions of our portfolio and large geographies around the world is, I think, very favorable as we look into FY '21.
Speaker 1
Thank you.
Speaker 0
Our next question is from Brandon Couillard with Jefferies. Your line is open.
Speaker 2
Hey, good afternoon. Hi, Brandon. Neil, just a quick one. You alluded to a two year CapEx program, I think, to modernize some plants. First part, is that growth oriented or cost oriented?
And should we expect a similar kind of 170,000,000 to 180,000,000 in
Speaker 12
fiscal twenty two?
Speaker 3
Yeah. It's a it's a it's a two year program, so I'm I'm I'm envisioning. Obviously, we're we're still a year away, but the f y '22, I think, will be similar from a CapEx perspective. And we've essentially got some facility up I I would call it just kind of resiliency of our supply chain with some facility upgrades we need to do. In other cases, we're looking to get some alternative sourcing sites for some specialized productions for diversification purposes, those types of activities to just make sure that our supply chain is secure.
All right. Thanks.
Speaker 0
The next question is from Mark Delaney with Goldman Sachs. Your line is open.
Speaker 3
Hi, Mark. Yes. Good afternoon.
Speaker 13
Thanks for taking the question. The company mentioned COVID-nineteen as one of the factors behind the muted seasonality this coming year. Can you elaborate a bit more on that? Or now that we've unfortunately seen some increasing cases in many countries, are you seeing any customers or certain geographies where there's actually some push outs in schedules that have been occurring? Or are more rating this as a potential risk we should be mindful about?
Speaker 3
No. I I think it's just broad uncertainty. Right? Nobody knows exactly exactly what's gonna happen, and and it's it's, you know, the question about seasonality. Typically, we see plus or minus a couple of points as we move from quarter to quarter.
You can go look at the history and see what that is. And all I'm we're saying two things. One, you've got this, you know, kind of broad overarching uncertainty around COVID, and then we've got this backlog burn that's gonna be happening. And we think those are gonna kinda more or less drown out the the typical typical seasonality that we would see in a current year. So we're expecting a much more steady revenue flow over the course of the next several quarters.
Speaker 13
That's helpful. Just a follow-up question on geopolitical issues that Keysight has been dealing with in the China market. And we discussed Huawei already on this call, but can you talk about any other customers where perhaps you've been doing business with? And has there been some increase in sanctions even beyond Huawei? I know that they've created some potential risk for tech companies.
And is there any business you may be doing separate from Huawei that you think could potentially come under additional restrictions we need to be thinking about or or maybe already has? Thanks.
Speaker 5
Yeah. So I well, I'll I'll
Speaker 3
let Mark comment on that as well. I mean, I think we've we're a couple of years now into this, you know, kinda ongoing, you know, back and forth around trade restrictions. And I will tell you that we've weathered it very well. Our business in China continues to do do very well. And and so whether you're talking about the initial tariffs or or, you know, companies added to the restricted party list or, you know, the the is the situations with ZTE and Huawei.
We've been through a lot of these things, and our China business continues to grow. We have a very broad portfolio. We have a very broad customer set. The types of things that Keysight does as a company is very well aligned with what's happening in China. And so, you know, I just think that and and Mark mentioned that we've been very good at redirecting our own internal sales and other resources, to where the market opportunities are.
Mark, don't know if you have anything that you want to add to that.
Speaker 2
Yeah. So, I would just reiterate that we've already pivoted with the most recent regulations. As a matter of fact, there were earlier ones back in June that was tied to the military end use customers in China and Russia and Venezuela that we also endured, and we made some changes associated with that. So, you know, we're closely monitoring this thing. We'll continue to be 100% compliant as we always are, and we have built a core capability to pivot quickly and go after the additional business that's available to us.
And as Neil just pointed out, for many, many quarters, we've been very successful in doing so.
Speaker 13
Thank you.
Speaker 0
Thank you. That concludes our question and answer session for today. And now let's turn the conference back over to Jason Carey for any closing remarks.
Speaker 1
Hi, Chris. Thanks for thanks for that. And I'd like to just turn it to Ron for some closing comments.
Speaker 2
Thank you, everyone, for joining us. We are very, very pleased with the results we delivered despite COVID and despite the trade environment, delivering record orders, record revenue, record gross operating margin and record free cash flow. We really believe and see that we have a very strong market position with very differentiated solutions across the ecosystem. And our solutions incorporate world class hardware, very good and strong software analysis capability as well as services. Our software content continues to increase.
Our services business is growing. And both of them together are giving us an even stronger business model with more recurring revenue. But our business model is strong. It was tested during the COVID period of time, and you could see the type of results that we can deliver. And last but not least, I really believe we have the best employees in the world that work very hard to bring our customers the best solutions in the world and support them as they try to innovate across their end markets.
And we are committed to create value as we've done in our first six years for our shareholders, and I really believe the best is yet to come. Thank you very much, and have a great day.
Speaker 0
This concludes our conference call, and you may now disconnect.