Keysight (KEYS) Q2 2025 Earnings Call Transcript

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DATE

Tuesday, May 20, 2025 at 4:30 p.m. ET

CALL PARTICIPANTS

President and Chief Executive Officer — Satish Dhanasekaran

Chief Financial Officer — Neil Dougherty

Vice President of Investor Relations — Paulina Sims

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RISKS

Neil Dougherty stated, "Our Q2 results included approximately $7 million of new tariff expenses in the cost of sales, which had a 60 basis point unfavorable impact on both gross and operating margins and resulted in an approximately $0.04 reduction in earnings per share."

Dougherty indicated Q3 FY2025 will experience "the most significant tariff impact."

Satish Dhanasekaran described the U.S. government’s "continuing resolution" as unprecedented, noting, "that does limit growth in new programs" for the Aerospace, Defense, and Government segment.

TAKEAWAYS

Revenue: $1.306 billion in Q2 FY2025, reflecting 7% reported and 8% core growth, surpassing the high end of guidance.

Earnings Per Share (EPS): $1.70; net income was $295 million on a weighted average share count of 173 million.

Orders: $1.316 billion in orders, up 8% year over year and sequentially.

Gross Margin: 65% gross margin company-wide, with CSG at 67% and EISG at 59%.

Operating Margin: 25%, an increase of 100 basis points, with CSG at 26% and EISG at 23%.

Segment Performance: CSG revenue grew 9% to $913 million in the second quarter. Commercial Communications and Aerospace, Defense, and Government revenues each increased 9% in Q2 FY2025.

EISG Revenue: $393 million in revenue, up 5%, as growth in semiconductors and general electronics outpaced declines in automotive and energy.

Software and Services Mix: Accounted for 36% of total revenue; annual recurring revenue comprised 28%.

Tariff Impact: New tariffs had a $7 million cost in Q2 FY2025, reducing gross and operating margins by 60 basis points and EPS by $0.04, with annual exposure expected between $75 million and $100 million.

Cash Flow and Balance Sheet: Ended Q2 FY2025 with $3.118 billion in cash and equivalents, $484 million in operating cash flow, and $457 million in free cash flow.

Share Repurchases: 1.042 million shares repurchased at an average price of $144, totaling $150 million in Q2 FY2025.

Backlog: Entered Q3 FY2025 with $2.4 billion in backlog, supporting a strong shipment schedule.

Guidance Update: FY2025 revenue growth guidance at the midpoint of 5%-7%, with annual EPS growth projected to slightly exceed the long-term 10% target.

Q3 Outlook: Revenue expected between $1.305 billion and $1.325 billion, with Q3 FY2025 EPS projected in the range of $1.63 to $1.69.

Acquisitions: The Spirent transaction cleared U.K. regulatory review with closing anticipated in Q3; other pending deals (Optical Solutions Group, Power Artist) will close subject to unrelated merger completion.

AI and Data Center: First-half FY2025 wireline sales grew by double-digits, driven by high-performance computing and AI network technology developments; CSG delivered the industry’s first 448 gig per lane optical transmission solution in Q2 FY2025.

Geographic Exposures: Less than 10% of tariff exposure relates to U.S.-China trade; the company’s global supply chain remains minimally exposed to China.

Order Trends: No evidence of order pull-in or pre-buys ahead of tariff surcharges; order funnel conversion and April intake were described as "fairly linear."

SUMMARY

Management raised full-year FY2025 guidance after robust revenue and order growth outpaced expectations, supported by strength across commercial and government end markets. Margin expansion was achieved in Q2 FY2025 despite new tariff expenses, with mitigation actions ongoing and full normalization expected by year-end. The Spirent acquisition received key regulatory clearance in March and remains on track to close in Q3 FY2025, enhancing the company’s presence in communications test solutions. Share buybacks continued at a meaningful pace, reflecting ongoing capital returns alongside strong free-cash-flow generation.

Recurring revenue from software and services represented a significant portion of sales in Q2 FY2025, with simulation and design engineering software orders posting double-digit growth.

AI-driven infrastructure buildouts and increased R&D investments in commercial communications underpinned wireline demand, with semiconductor and silicon photonics engagements accelerating.

The CSG segment reported double-digit order growth in commercial communications in Q2 FY2025, while EISG reversed a six-quarter revenue decline on strength in semiconductor and electronics markets.

Tariff exposure, while impactful, is being addressed through pricing, cost actions, and supply chain realignment, with the greatest earnings drag concentrated in Q3 FY2025 and mitigation measures anticipated to conclude in the fiscal fourth quarter.

The company expects continued resilience in its operating model and demand pipeline despite macroeconomic and geopolitical risks, including ongoing U.S. government continuing resolution impacts on new defense program growth.

INDUSTRY GLOSSARY

CSG (Communications Solutions Group): Segment providing test and measurement solutions for communications, including commercial and government markets.

EISG (Electronic Industrial Solutions Group): Segment delivering solutions for electronic, semiconductor, industrial, automotive, and energy customers.

OFC: Optical Fiber Communication Conference, a key industry event for showcasing advancements in optical transmission technologies.

BERT (Bit Error Rate Tester): Instrument used to assess data transmission quality and integrity in digital communication systems.

AWG (Arbitrary Waveform Generator): Instrument for generating complex electronic signals to test equipment and systems.

DSO (Days Sales Outstanding): Measure of the average number of days it takes a company to collect payment after a sale.

OEM (Original Equipment Manufacturer): Company that produces parts and equipment that may be marketed by another manufacturer.

Full Conference Call Transcript

Satish Dhanasekaran: Good afternoon, everyone, and thank you for joining us today. During the second quarter, Keysight delivered revenue of $1.3 billion and earnings per share of $1.70, both of which exceeded the high end of our guidance. This marks the second consecutive quarter of revenue growth driven by continued momentum in CSG and return to growth in EISG. The demand environment was solid in the quarter with orders growing 8% year over year and 4% sequentially to $1.3 billion. Even as we are monitoring the overall macro environment, we entered the second half with a healthy pipeline of opportunity and strong customer engagements. Neil will have more details on the tariff impact in his remarks.

Overall, our business results demonstrate the resilience of our business and the durability of our financial operating model, which is underpinned by a flexible cost structure, supply chain, and operating capabilities that allow us to quickly adapt to external dynamics. As a result of our multiyear investments, we have a diversified global supply chain, which is largely based in Southeast Asia, with minimal exposure in China. Despite the near-term uncertainty, we are confident in our market leadership and strength of our operating model, and our ability to generate value for our stakeholders. Our capital allocation priorities have not changed.

We are investing for the long term while also pursuing a balanced return of capital enabled by a strong free cash flow conversion. Over the past twelve quarters, we have returned over $1.7 billion or roughly 50% of free cash flow to investors via repurchases. Turning to business segments. In CSG, commercial communications orders grew double digits. Demand remains robust in wireline, where the ongoing data center infrastructure expansion is driving order strength. We saw continued deployment of 400 and 800 gig Ethernet technologies in AI data center applications.

R&D investments in 1.6 terabyte electrical and optical technologies as well as expansion of new protocols in AI data center networks are fueling demand as the entire industry is innovating and developing new applications and services. This quarter at OFC, we demonstrated the industry's first solution for 448 gig per lane optical transmission, a key building block in the deployment of 1.6 and 3.2 terabyte networks. The depth and breadth of Keysight's capabilities in the electrical and optical and wireline protocol stacks positions us well to enable ongoing innovation in high-performance computing memory and networking. Wireless orders grew in Q2.

We saw a steady pace of R&D activity related to 5G advanced and early 6G research, as well as investments in non-terrestrial networks. While smartphone supply chain activity remained stable, innovation and investment in R&D in radio access networks continued to grow. Keysight's new digital twin and system emulation capabilities are enabling non-terrestrial applications and expanding our customer engagements. In aerospace, defense, and government, orders grew this quarter driven by strength in the US and Europe. Ongoing investment in spectrum operations and space applications drove growth. Although the US will be operating under a continuing resolution for most of the year, overall demand and pipeline of opportunities remain robust with prime contractor backlogs at record levels.

Investments in defense modernization remain a top priority for many countries as reflected in the increased budget proposals in the US, Europe, and Asia. Keysight is a trusted partner in this ecosystem, delivering advanced high-fidelity test capabilities that simulate real-world electronic threats in lab environments. This quarter, Keysight won a notable deal with a major defense agency in Europe to modernize its testing capabilities for antenna and radar applications, which are key to mission-critical applications. Our innovation pipeline is driving a steady cadence of new products and solutions, which this quarter included higher frequency extensions to our phase noise analyzer for defense applications, and a new digital communications analyzer for 224 gig transceiver test enabling wireline and general-purpose use cases.

Turning to Electronics Industrial Solutions Group, the demand environment remains mixed while the revenue returned to growth after six quarters of decline. In semi, the demand for our wafer test solutions from large foundry and IDM customers remains strong. Leading-edge process node investment was augmented by rapid growth in high bandwidth applications. Customer engagements for silicon photonics and co-packaged optics accelerated within the quarter, as the industry works to address performance limitations across latency, bandwidth, and power in the AI data center. In automotive, while orders and revenues were down, the business has largely stabilized. Engagements with OEM customers remained steady with investments in software-defined vehicle capabilities, including cybersecurity, radar screen emulation, and ADAS chipset development.

This quarter, we secured a key win with a major automotive OEM for design and test of their home energy management systems. General Electronics orders grew for the third consecutive quarter, although at a lower rate. Growth in multi-industrial and med tech customers for both R&D and manufacturing solutions was partially offset by contraction in US education funding and continued normalization in the distribution channel. Moving to software, Design engineering software orders grew double digits reflecting a healthy demand for our RF EDA solutions. We are seeing growing interest from industrial customers looking to apply simulation and virtual prototyping in the mechanical domain.

With respect to our recent ESI acquisition, we are enabling next-generation industrial design by delivering a panel forming solution to a large European auto OEM that will drive efficiencies through their manufacturing processes and optimize their production timelines. In closing, we are pleased with the recovery that's underway. Our end markets have largely performed in line with our expectations heading into the year. I am once again proud of the Keysight team's execution in this quarter in what remains a dynamic environment. Keysight's broad portfolio of differentiated solutions positions the company to outperform a variety of market environments. We continue to make deliberate multiyear investments aligned with long-term technology trends creating opportunities now and into the future.

As we move through the second half, we remain focused on executing on what we control and continuing to deliver value to our customers and stakeholders. With that, I'll turn it over to Neil to discuss our financial performance and outlook.

Neil Dougherty: Thank you, Satish, and hello, everyone. Second quarter revenue of $1.306 billion was above the high end of our guidance range of 7% on a reported basis and 8% on a core basis. Orders of $1.316 billion were up 8% on both the reported and core basis. Looking at our operational results for Q2, we reported a gross margin of 65%. Operating expenses were $516 million, up 4%. Q2 operating margin was 25% and increased 100 basis points over last year. Turning to earnings, we achieved $295 million of net income and delivered earnings per share of $1.70. Our weighted average share count for the quarter was 173 million shares.

Our Q2 results included approximately $7 million of new tariff expenses in the cost of sales, which had a 60 basis point unfavorable impact on both gross and operating margins and resulted in an approximately $0.04 reduction in earnings per share. Moving to the performance of our segments. Communications Solutions Group generated second quarter revenue of $913 million, up 9% on a reported and core basis. Commercial communications revenue of $612 million was up 9%, reflecting sustained strength in wireline and growth in wireless. Aerospace, defense, and government achieved revenue of $301 million, an increase of 9%. Altogether, CSG delivered a 67% gross margin and a 26% operating margin.

The Electronic Industrial Solutions Group generated $393 million in revenue, an increase of 5% with growth in semiconductor and general electronics more than offsetting a decline in automotive and energy. EISG delivered a 59% gross margin and a 23% operating margin. Software and services accounted for approximately 36% of Keysight revenue, while annual recurring revenue was 28% of the total mix. Moving to the balance sheet and cash flow. We ended the quarter with $3.118 billion in cash and cash equivalents, generating cash flow from operations of $484 million and free cash flow of $457 million. We intend to use the net proceeds for general corporate purposes, which may include partially funding the previously announced acquisition of Spirent.

With regard to pending acquisitions, the UK Competition and Markets Authority cleared the Spirent transaction in March. We are progressing through the review process with other regulatory agencies and expect the transaction to close in Keysight's third fiscal quarter. In addition, the acquisition of Optical Solutions Group and Power Artist is anticipated to close shortly after the Synopsys to ANSYS transaction is completed. Lastly, we repurchased 1.042 million shares this quarter at an average price of approximately $144 for a total consideration of $150 million. Now turning to the current environment, tariffs, and our outlook.

We have a diversified global supply chain with minimal exposure to China and have already taken action across multiple factors to reduce the incremental impact of tariffs. Our multi-pronged mitigation approach spans our global manufacturing footprint and sourcing strategies as well as pricing and cost actions. Based on actions taken to date, we estimate our annual exposure at approximately $75 million to $100 million. We are working to further reduce this exposure and offset any remaining impact. Given the high priority that we place on maintaining our long-term customer relationships, our pricing actions were not applied to pre-tariff backlog.

As a result, and assuming tariff rates remain at the current levels, the most significant tariff impact is expected in Q3 with full mitigation by the end of the fiscal year. Keysight currently has $2.4 billion in backlog and enters Q3 with a solid scheduled shipment position. Despite the dynamics and uncertainty of the current macroeconomic environment, as Satish mentioned earlier, at this point, we have not seen any material adverse effects on demand from tariffs and are therefore raising our full-year growth expectations. We now expect FY 2025 revenue growth at the midpoint of our 5% to 7% long-term target and annual EPS growth slightly above our long-term 10% target.

For the third quarter, we expect revenue in the range of $1.305 billion to $1.325 billion and Q3 earnings per share in the range of $1.63 to $1.69 based on a weighted diluted share count of approximately 173 million shares. Implied in this guidance is the assumption that tariffs remain at current levels for the year. With that, I will turn it back to Paulina for the Q&A.

Paulina Sims: Thank you, Neil. Operator, will you please ask the instructions for the Q&A, please?

Operator: Ladies and gentlemen, if you would like to ask a question, the first question comes from Tim Long with Barclays. You may proceed.

Tim Long: Hi, Tim. Hi. Maybe one and then a follow-up. Just if we could just go back to AI. I know you guys have been giving us examples each quarter of where you guys are seeing traction. It seems like, you know, across the hardware ecosystem and emulation simulation as well. Can you just kinda update us on what kind of, you know, new activity you're seeing there and how meaningful it is for the business? And then just on the follow-up, if you could just give a little bit more color on the orders and pipeline to get to the full-year guidance. I think normally, we do see orders pick up towards the second half of the year.

So just curious what you're seeing in the pipeline to get confidence in the second half. Thank you.

Satish Dhanasekaran: Thank you, Tim. Obviously, you know, AI, you know, we view it as a long-term secular trend. And with a clear multiyear roadmap that's forming and a great fit to our strategy of not only being a physical AI tool provider but also going up the stack with physical and protocol layer and offering more solutions to customers. The big megatrends are clear. Right? We all know the AI workloads are growing. And we're making contributions around a number of technology fronts, including in memory, compute, networking, with new standards that are forming. So our broad portfolio is really in play as we engage with these customers.

And where we see the industry right now is trying to solve a number of the scale-up, like, scale-out challenges as they deploy this digital infrastructure. Right? So that's the action or activity that's being driven and we had another strong quarter. So for the first half, you know, last year, we said our wireline business was roughly a billion dollars over a billion dollars, I should say, in sales. And for the first half, it grew double digits. So we feel good about our position in this emerging space, and we think it's a long-term growth opportunity for us that we're very excited about.

With regard to the progression of orders and what's baked into our guide, again, look, I think we've said this before that we despite all the uncertainty, and chatter out there and the customers are obviously paying attention to all the tariff talks and all the macro concerns, I you know, we have not yet seen any material change in customer behavior with regard to their immediate plans. And so, as we enter the quarter, we obviously had a strong finish for Q2. As we enter Q3, our pipeline is solid and supports our guide. And we had a pretty strong uptick in pipeline activity as it relates to the second half. So we feel good about the second half.

Obviously, there are risks that we're monitoring like everybody else. But we're focused on what we control and feel confident about where we stand today.

Tim Long: Okay. Thank you.

Satish Dhanasekaran: Thank you. Thank you.

Operator: The next question comes from Matt Niknam with Deutsche Bank. You may proceed.

Matt Niknam: Hey, guys. Thanks so much for taking the question. One question and then one follow-up. I guess, first on my main question, you obviously raised the top-line outlook, I guess, on average, by about a hundred bps relative to the prior 5%. So I'm curious maybe where you're seeing a little bit of an incrementally improved view relative to three months ago. That's the first question. Second, just to follow-up on cash flow from ops. It was meaningfully stronger. I'm just wondering maybe for Neil, anything unique on the working cap side and then maybe how to think about cash flow from ops and working cap over the duration of the fiscal year. Thanks.

Satish Dhanasekaran: Thank you. I think, again, as I mentioned before, we look at old performance we've had in the first half, we take a look at our pipeline of opportunities we have, the strong backlog position we have, and we then have applied this to essentially raise the top-line expectations for the full year. Again, there's a lot of macro risks and other things people are monitoring, we have not seen any material change in customer behavior. And if you recall at the beginning of the year, we said we thought this year would be a slow gradual recovery in our markets. And we feel like that's exactly the trajectory we're on.

So that's where we find ourselves at the end of the first half and feel confident about where we are. But like everybody else, we continue to monitor the risk due to tariffs and the geopolitical environment.

Neil Dougherty: Yeah. So the only thing I would add to that Satish just said with regard to the outlook for the year, as everybody knows, we tend to see a seasonal uplift in the fourth quarter. Still expecting the fourth quarter to be our strongest quarter of the year, and that lends to that guidance increase. As it relates to cash flow, yeah. So obviously, strong cash within the quarter. There are a couple of things in there. So first of all, that did include a little less about $60 million worth of a gain on a hedging contract associated with the purchase price for Spirent.

We had put in a contract in place about a year ago set to expire at the end of our first half, which was our original thought on timing of the close of that transaction. So we closed out that transaction and essentially rolled it forward. But when we closed it out, we did recognize about a $60 million gain on that hedge. In addition, we did see some working capital improvements. Inventory days were down by about ten, DSO was down by about three, so that contributed to the strong cash flow performance as it's significantly lower tax payments than in the year-ago quarter.

Operator: Thank you. The next question comes from Mark Delaney with Goldman Sachs. May proceed.

Mark Delaney: Yes. Good afternoon. Thank you very much for taking my question. Just wanted to better understand the tariff topic. Maybe first one, just to level set everyone including myself, the $75 million to $100 million is that the gross amount of exposure that you have and the net effect this year is maybe something less than that? Or is the $75 million to $100 million what you expect the drag on profits to be for this year?

Neil Dougherty: Yeah. So $75 million to $100 million is a gross annualized number. Obviously, you know, the thing went into effect in April, so we only have, you know, a little less than seven months of total impact. So $75 million to $100 million is the gross number. We are working to offset that. Although, as we said in our previous remarks, to the extent we're passing those costs on to customers, we've made no attempt to reprice backlog. And given that we entered Q3 with about $2.4 billion of backlog, it's gonna take some time for those offsets to materialize.

And so, you know, relatively little here in Q3, a little bit more in Q4, but by the time we get to Q1, we expect to have those tariff costs fully mitigated.

Mark Delaney: That helpful, Neil. And that was what my follow-up was on. You know, if you're not raising price on backlog, maybe you can help us better understand the mitigating actions that you are taking and your confidence in mitigating the tariffs as you exit the year? Thank you.

Neil Dougherty: Yeah. So, I mean, I think as we think about tariffs, we think of kind of two opportunities. One, what are the actions that we can take to reduce our overall tariff exposure, leveraging our global supply chain leveraging our manufacturing footprint, taking actions to actually reduce tariff costs, and then once we get to kind of we've optimized the tariff cost side, the question is, what can you do to further mitigate either by passing those costs on via price or surcharges of some sort or reducing costs elsewhere in your P&L. And so we have actions going on across all of those work streams. Now when I said we're not raising price on existing backlog, right?

So essentially, we said, hey. If you had orders that were already on our books, that we weren't gonna go back and try and recover tariffs on those. But we had taken actions forward-looking on new quotations starting in, you know, about mid-April.

Satish Dhanasekaran: Yeah. Mark, I just to Satish, just to chime in, you know, we have a pretty resilient supply chain operations that is agile and we have a considerable amount of operational realignments that we can still work on, you know, because at this point, we're assuming 10% tariff sort of is the base case for us. And should that materially change, we would be prepared to respond to those scenarios as well. You know, customer pricing and strategies, it's definitely a part of it. But it's also all the other operational alignments that we can make with our partners who we have a multiyear relationship with that can help us scale across geographies if needed.

Mark Delaney: Thank you very much. I'll pass it on.

Operator: Thank you. Please limit yourself to one question and one follow-up only.

Meta Marshall: Great. Thanks. A couple of questions for me. Just one know that your aerospace and defense business is kinda relatively split between kind of US and allies. But just wondering if you had seen any kind of pushback on, you know, Ally orders that were aligned to US programs or just kind of any commentary you could kind of give on aerospace and defense. And then just also kind of following up on that of noted that you said kind of minimal China impact, but just you know, how much of that $75 to $100 of impact that you guys are talking about from a gross perspective is from shipping into China versus kind of shipping into the US? Thanks.

Satish Dhanasekaran: Thank you, Meta. I'll have I'll take the aerospace defense and you can quantify the China impact. I'll just say that the strong quarter with growth in orders, as I mentioned, even under a continuing resolution, where that we've been operating under, and this is unprecedented that we're still under continuing resolution maybe for full year. And so that does limit growth in new programs and such, but we saw some good orders bookings again with our Prime contractors in the US. And actually had a double-digit order growth in our European business. Just to give you some examples, we were awarded by NATO four x contract, which is public to modernize radar and electronic support measures.

We also were selected by the US Army for, you know, for validating zero trust security on the unified network. So the, you know, spend environment remains strong, especially with the prime contractor backlog. Again, this is a business I want to remind you. It's always difficult to call on a quarterly basis but easier to call on a longer term. Because the trends are clear. And we look at it longer term and say, you know, the US budget next year is likely to go up. European budgets for defense are likely to go up with the programs being put in place. And so and we feel good about our portfolio position in aerospace defense.

Neil Dougherty: Yeah. I mean, and just to get to the question about China, so US-China-US, both directions is less than 10% of tariff exposure.

Meta Marshall: Okay. Great. Thank you.

Satish Dhanasekaran: Thank you.

Operator: The following comes from Aaron Rakers with Wells Fargo. You may proceed.

Aaron Rakers: Yeah. Thanks for taking the question. Two, if I can, I'll just ask him right away as well. So first, I think, Neil, you know, as we as we talk about, you know, the guidance and getting up north of that 5% growth or in that 5% to 7% range that you alluded to. Can you just remind us again of how we think about the incremental margin for the company? I think all the way back at the Analyst Day, you talked about anything north of 5% dropping through, like, a 40% incremental margin.

And what I'm trying to get to is just the pace of how we could think back to, you know, getting op margin, you know, back above 30%. And then as a follow-up or as the second question, I should say, is that can you talk a little bit about the wireless business? You know, that I think previously talked about kinda think of that as being stable. But it sounds like that's actually performing a little bit better. How do you think about the durability of that wireless business? Thank you.

Neil Dougherty: Yeah. So, Juan, I'll start with the first one here. Yeah. Incremental. You're absolutely correct. What we basically said is, you know, anytime our business is growing 5% or better that we would expect to drop through that growth at an operating incremental of about 40%. Now I would point out that the tariffs are new and substantial incremental costs that are in the short run going to impact our ability to deliver on that increment.

Aaron Rakers: Yep. And on the wireless business?

Satish Dhanasekaran: Yeah. On the wireless business, you know, again, we're continuing I would say the headline is we're continuing to see stability strength in the infrastructure side, still the smartphone-related businesses, you know, some segments are so soft. Especially in China. So still monitoring but stable. But soft. I would say the real strength is in the network infrastructure side with open RAN. Some of the latest standards releases with AI, and some early 6G research really driving some of the spend and customer engagements. But we have a strong position in this space, and we continue to invest for the longer term here to maintain our leadership. And in the space.

Operator: Thank you. The following call is from Robert Jameson with Vertical Research. You may proceed.

Robert Jameson: Hey, good afternoon. Thanks for taking my questions in the next quarter. Just quickly on software and services, it's a growing part of the business. Up to 36% of revenue, recurring down to 30% now. Are there any, like, investments that you're making to further accelerate growth here to given the margin profile of the businesses?

Satish Dhanasekaran: No. Thank you. Again, you know, a big part of our strategy, and if you look at the business and how it performed in a downturn, as you rightfully point out, is a function of software and services because it's been such a big part of the company's resilience especially even as the top line comes under some pressure. So we you know, this is clearly the area of focus across all our businesses. You know, we have a strategy to grow the software and services. But one particular area really excited, we saw double-digit growth in our simulation business as an example. It's an area where we have placed a lot of M&A dollars and focus.

If you remember, we acquired ESI and now we're also potentially beneficiaries of this Synopsys ANSYS transaction where we might get a couple more acquisitions to bolster our presence in the simulation space. And it does two things. Right? It increases our software and recurring revenue, but equally, it allows us to engage with our customers earlier in the design cycle, which, again, fits our strategy of being a bigger player in the R&D parts of our market. And now as recovery does happen in our end markets, you will see that number maybe take back. You know, as a percentage of the total mix just a little because we're starting to see some of our core business recover.

But I think the long term, we still feel like there's more upside to driving the software as a percentage of revenue.

Robert Jameson: Okay. Thank you. And then just on AI, I mean, it's been since the been seen and growing nicely. But I you know, and maybe you addressed this earlier, but beyond tech testing, you know, like, the high-speed interconnects and network infrastructure, are there any other kind of test applications or demand that you're seeing from customers within that realm? Or is that kind of, you know, coming from some of the emulation stuff that they mentioned on, you know, the testing of how compute latency, etcetera, is working its way through the data center as they are, you know, reconfiguring things for, you know, higher network speeds and things like that.

Satish Dhanasekaran: Yeah. I think it's important to characterize this not just as cable test, but it's important to characterize it as the challenges in the digital infrastructure that's being put in place for AI are very different. Like, when customers are trying to look at the scale-up and scale-out challenges they face, you know, what might be an interconnect really turns into a mission-critical fail point. If it's not performing right and the cost of failure gets up pretty substantially. So we're engaging with our customers on those mission-critical needs that they have today. But equally, from a strategic sense, we're looking at where is the industry going in five years.

And I can tell you that the state of the art of the technology keeps growing. There's this roadmap that's forming around multiple dimensions, we're participating in those. To enable it. So we're there for our customers. And what we see is a big trend of pulling in the timelines because of the rapid increase in the AI workload. Right? So all of this is a pretty rich opportunity for us. We've also, along the way, have designed wins in the software emulation space, which allows customers to isolate their performance in the AI data center and say, where is the bottleneck to get the true performance? So we're working with them on those as well.

So across the board, across physical and protocol layer, we're continuing to grow our contributions to this marketplace.

Robert Jameson: Great. Thank you very much.

Operator: Thank you. The next comes from Rob Mason with Baird. May proceed.

Rob Mason: Oh, yes. Good afternoon. Just a couple of questions. On the general electronics business, I'm curious just given all the realignment of supply chain activity, you know, maybe it's round two versus tariffs the last time, is companies look at where their manufacturing footprints, you know, need to reside. Can you just speak to maybe the impact on that business from a demand side? And, again, I'm maybe thinking more on the production test side if that's an influence. And then I'll just go ahead and ask my follow-up. You know, Neil, could just to think about the tariff impact in the third quarter, you know, is it kind of roughly a doubling of what you experienced in the second?

Neil Dougherty: Yeah. I'll take the second one first here. You know, I think it's likely a little bit more than that. We had about three weeks of tariff impact in April versus obviously a full quarter. Now we have already taken mitigating actions that are having a positive impact. So I don't think you can extrapolate totally forward from $8 million just based on the number of weeks, $7 million. But it is a little bit more than a doubling. It is more than a doubling of what we saw in Q2 just given the time involved.

Satish Dhanasekaran: Yeah. I think, you know, when you look at the general electronics business, you know, given it's a broad marketplace for us in terms of the number of different types of applications that end market represents. We see no change in sort of the areas such as digital health and research because those tend to be durable in nature. And the manufacturing parts of it do move around. So on one hand, you know, China still remains weak in that area. But I would say that there's a lot of recent conversations we're having with customers because they are trying to diversify their manufacturing footprint.

Now it's not mutually yet reflected in our results, but could be an opportunity for us to engage in that we're working with customers on. So it's still early days. But it's driven by the tariffs and what might happen there's a lot of scenario planning that's occurring, you know, and it'll probably be playing out over the next 90 to 180 days.

Rob Mason: I see. Thank you.

Satish Dhanasekaran: Thank you.

Operator: The following comes from Adam Thalhimer with Thomas Davis. You may proceed.

Adam Thalhimer: Hey. Good afternoon, guys. Great quarter.

Satish Dhanasekaran: Thank you, Adam.

Adam Thalhimer: Can you parse through orders a little bit? I'm curious if there was any to what extent you saw prebuy activity ahead of any surcharges and what our expectation should be for order trends after the surcharges went into effect.

Satish Dhanasekaran: Yeah. So just taking a look at the orders in Q2, you know, orders progressed fairly linearly in the quarter. The funnel conversion was what we expected. We had a strong intake in the funnel as well, which is what we reflected into Q3. And then I would say our April was strong, in part because it's the end of our first half for our compensation for our Salesforce. So it does tend to have a strong April. So no real change. You know, we didn't see any difference in pull-in, pull-outs, or cancellations, or anything of that kind.

And that's why our position is, you know, while customers are watching the macro and evaluating the risk associated with it, we haven't seen any material change in customer behavior.

Adam Thalhimer: Good to hear. And then secondly, I wanted to ask about Asia. The revenue there was really strong in the quarter. And maybe you can just give some high-level thoughts on China demand.

Satish Dhanasekaran: Yeah. I would say, you know, Asia was strong. And, again, it's across all of our segments, really. Commercial communications being the leader, semiconductor saw strong demand as new nodes and new technologies such as silicon photonics are being deployed. And general electronics also had some growth in Asia. I would just maybe make a comment about China. You know, orders were flattish for the quarter in China. With strengths in a few sectors. But, clearly, as I mentioned before, the general electronics, the manufacturing exposure, was weak, and automotive in China was also weak. We continue to monitor the POS demand, although we have a very small indirect business. We can, you know, monitor that.

It seems largely in line. So, China, I would say, continues to hold up well in this environment.

Adam Thalhimer: Thanks, Satish.

Satish Dhanasekaran: Thank you.

Operator: Thank you. The next question comes from Samik Chatterjee with JPMorgan. You may proceed.

Samik Chatterjee: Hi. Thanks for taking my question. Satish, maybe if I can I saw my sort of try to hi? Hi. Good to hear from you. So on the drivers of wireline demand, and No. Thank you. Drivers of wireline demand, I'm trying to sort of address it maybe in terms of how to think about sustainability. And your customers clearly are doing well on volume, but how should we think about the strength you're seeing driven by progress on R&D from your customers relative to maybe sort of what seeing on their volume outlook and driven by production.

So maybe if you can share any color about communications is very R&D aligned for you, but what does it look like for wireline? And is the demand you're seeing there are you selling new testers when it comes to, like, either silicon photonics or CPU support? Or are you just seeing more sort of customers buying just because their volume outlooks as stronger? Anything you can share on that front? And I have a follow-up. Thank you.

Satish Dhanasekaran: Oh, good. That's a great question, Samik. I think, you know, I would just say, you know, when we looked at our wireline business, say, a year or two ago, we have said the majority of the business R&D and I would probably put it as 80/20-ish roughly as the ratio of R&D to manufacture. We've probably seen a ten-point swing in the manufacturing in that area, but that's sort of where we are still heavily R&D oriented. But we're clearly also benefiting from all of the manufacturing activity that's happening as the industry is trying to ramp for digital.

But when I look at the portfolio of products that we service, you know, all the way early R&D to, call it mainstream or R&D or validation. Through deployment, you know, whether it is with our AWGs, BERTs, scopes, our silicon photonics, wafer test systems, network analyzers, software with our AI benchmarking, and network speed emulator. So pretty broad category of products, that we're selling to. And, actually, as we as I think about the whole first half, I would say the number of customers that participate in that has also grown for us. Which, which is a good sign that the ecosystem is expanding.

As more companies are coming in driven given that this is going to eventually be a longer-term opportunity. And when I look at the when I look at some of the data trends that are going on and the standards progressions, really bodes well for R&D business. We'll have some times when we'll pick up manufacturing demand as well because we have a portfolio, but strategically, the R&D business is more valuable to us.

Samik Chatterjee: Okay. Got it. Got it. And for my follow-up, if I can sort of stay with the wireline demand, but more sort of when we think about ad adoption of technologies like CPU and silicon photonics, I'm imagining sort of visualizing it as more of the test demand moves towards a bit more sort of semiconductor level testing. So anything you can share there in terms of how you see the competitive landscape? Does it change from what you've had instead of 400 gig, 800 gig? And do you think you have the sort of entire stack to address some of those complexities?

Or is there something that you need to add to the portfolio to address sort of when the overall sort of technology moves more closer to semiconductor testing?

Satish Dhanasekaran: No. You're very astute to pick up the change, right, between electrical to optical or that conversion. It's been an area of emphasis and investment for us. Especially as these things go into silicon. Is why we invested about eighteen months ago to intercept the demand from silicon photonics. We talked about this on a call. As well. And we're now benefiting from that. That requires bringing together optical capabilities with our electrical capabilities and probing and complex metrology. So, really, in our wheelhouse is a company to go after this opportunity, co-packaged optics is another great example of what I saw from customers. I think that's accelerating as well. And if we need more capabilities, we can acquire talent.

But I think we have a strong foundation to start with today. That we actually at OFC we showcased multiple firsts in this area, 448 gig transmission, key enabler of 3.2 terabits. And so on and so forth. So we had about fifty demonstrations. So, you know, it will continue to grow. But you're right. This is where the puck is moving to, and we find ourselves having a strong foundation to intercept this.

Samik Chatterjee: K. Great. Great. Thank you. Thanks for taking my questions.

Satish Dhanasekaran: Thank you.

Operator: Thank you. We have a question from Mehdi Hosseini with SIG. You may proceed.

Mehdi Hosseini: Yes. Thanks for letting me ask a question. One follow-up on the wireline. And, Satish, I just wanna look at the big picture you talked about, the connection is moving from copper to actually, moving towards optical. And when you look at the entire market for both networking test as well as the testing that happens with the component and component migrating to optical. Would it be fair to say that your content would increase as you migrate from 800 gig to 1.2 terabyte? And if the content increases, including both system-level test and semiconductor, what is the magnitude of the increase? Or you can add it help us qualitatively or quantitatively, and I have a follow-up.

Satish Dhanasekaran: No. That's a look. I think I don't know that I would say that from what we see that it's either gonna be electrical or optical. I think it's electrical for some applications where you obviously have a better sort of economics and then optical where you need the performance and, which where the buck is moving to. So I think this sort of hybrid is where the solutions are needed. And I think being a company that has both technologies, we find ourselves in a really good position across the stack, as you pointed out, memory, compute, networking, so on and so forth.

Now with regard to the magnitude of the opportunity, typically, as the complexity goes up, we would see the types of solutions that customers need, especially in early R&D, to be more complex and, therefore, we're adding more value to our customers as we get there. Now as those technologies mature, obviously, the puck moves to the next one. And therefore, the volume may drop on the previous technology. It's always the case that happens. But the net effect of these overlapping waves of technology is it's, you know, it really supports our long-term growth expectations for the company that we have set to be in the 5% to 7% range.

Mehdi Hosseini: Okay. And then follow-up for Neil. If I just take a midpoint of your revenue growth this year 25 assuming that the sequential growth is stronger in October versus July, and embedding the tariff impact into your margin profile would it be fair to say that there is a slight decline in operating margin from April to July and it would go kind of sideways from July to October. So your fiscal year 25 operating margin would be kind of flattish compared to fiscal year 24?

Neil Dougherty: Yeah. I mean, I think as we look forward here, I think we're kind of range-bound, I would say. You know, in a pretty tight range. Obviously, we're going to see we would expect to see a seasonal uplift here as we move from Q3 to Q4. But and as always, we would expect the absent tariffs to continue to drive a strong incremental on that flow through.

Mehdi Hosseini: Okay. Thank you.

Operator: Yeah. That concludes our question and answer session for today. I would like to turn the call back to Paulina Sims for any closing comments.

Paulina Sims: Thank you, Tamia, and thank you all for joining us today. Have a great rest of your day. This concludes our conference call. You may now disconnect.

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