Good day, ladies and gentlemen. And welcome to the Keysight Technologies Fiscal Second Quarter 2021 Earnings Conference Call. My name is Gabriel and I'll be your lead operator today. After the presentation, we will conduct a question-and-answer session. [Operator Instructions] Please note that this call is being recorded today, Wednesday, May 19, 2021 at 1:30 PM Pacific Time.

I would now like to hand the conference over to Jason Kary [Phonetic], Vice President, Treasurer and Investor Relations. Please go ahead, Mr. Kary.

Jason Kary - Vice President, Treasurer and Investor Relations

Thank you. And welcome, everyone, to Keysight's second quarter earnings conference call for fiscal year 2021. Joining me are Ron Nersesian, Keysight's Chairman, President and CEO; and Neil Dougherty, our CFO. Joining us in the Q&A session will be Satish Dhanasekaran, Chief Operating Officer; and Mark Wallace, Senior Vice President of Global 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's segment results. Following this conference call, we will post a copy of the prepared remarks to the website.

Today's comments by Ron and Neil will refer to non-GAAP financial measures. We will also make references to core growth, which excludes the impact of currency movements and acquisitions or divestitures completed within the last 12 months. You will find the most directly comparable GAAP financial metrics and reconciliations on our website. All comparisons are on a year-over-year basis unless specifically noted otherwise.

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 highlight that management is scheduled to participate in upcoming virtual investor conferences hosted by JPMorgan, Stifel, Baird, UBS and Bank of America.

And now, I will turn the call over to Ron.

Ron Nersesian - Chairman, President and Chief Executive Officer

Thank you, Jason. And thank you, everyone, for joining us. Keysight delivered a record quarter and we are entering the second half of the year with momentum. Our broad portfolio of differentiated solutions continues to drive growth across a diverse set of growing markets.

Today, I'll focus my comments on three key headlines. First, we delivered outstanding Q2 results with all-time record orders, revenue and free cash flow. Second, Keysight is enabling leading edge disruptive innovation around the world. Our solutions have significant differentiation and contribute significant value to customers, which is fueling our growth for the long-term. Third, while we are managing longer lead times and component availability, our leading market position, strong customer relationships and supply chain resiliency give us the confidence in our ability to deliver on our commitments.

Now let's take a deeper look across our second quarter performance across both business segments. Record orders of $1.3 billion grew 22%. Revenue grew 36% to $1.2 billion, which was an all-time high. We delivered second quarter gross margin of 64%, operating margin of 26% and earnings of $1.44, which was above the high end of our guidance and represents 85% year-over-year earnings growth.

We also achieved record free cash flow of $369 million. Over the last 12 months, Keysight generated just over $1 billion of free cash flow that we've deployed through approximately $500 million in acquisitions and $455 million in share repurchases. We continue to be active and disciplined in our capital deployment.

Second quarter strength was broad-based with double-digit order and revenue growth across all markets and regions. Outstanding results by both business segments demonstrates the power of Keysight's diversified portfolio in 5G and beyond. Our Electronic Industrial Solutions Group achieved its third consecutive quarter of record revenue with strong double-digit order and revenue growth in general electronics, semiconductor and automotive. The breadth of our contributions across multiple industries is exemplified by our double-digit order and revenue growth in our general electronics business.

With ongoing investment in broad digital transformation, including advanced consumer electronics, digital healthcare and industrial IoT, Keysight is enabling innovation in capturing technology inflections for the IoT ecosystem. Strong demand for our semiconductor solutions drove record orders and revenue. Customer investment in advanced technology nodes remains high, while capacity is expanding for mature processes to address surging global semiconductor demands.

In automotive, record orders resulted from improved macro conditions in increasing investments in EV and AV technologies. Keysight solutions portfolio for the automotive market continues to expand with new advanced technologies such as AC power emulation, millimeter wave radar, power semiconductor technology, automotive Ethernet, C-V2X and cybersecurity software systems. As the reinvention of automotive ecosystems continues, Keysight is enabling the disruptive innovation of new mobility technologies.

Our Communication Solutions Group achieved record orders and delivered double-digit order and revenue growth in commercial communications and aerospace, defense and government. Aerospace, defense and government revenue grew 46%, driven by strong demand in space, satellite, signal monitoring, 5G and early 6G research applications.

Keysight's engagement with key industry players remains strong. We recently enabled a large prime contractor's first test bed and have secured multiple 5G solutions wins in the aerospace, defense and government markets. Commercial communications orders and revenue both grew double-digits, driven by the ongoing investments in 5G and 400-gig, 800-gig Ethernet solutions for data centers. As 5G progresses and deployments drive sustained investment, we are uniquely positioned to capture the opportunities ahead as the ecosystem scales. Recent engagements include a broadening set of new customers as well as key industry players such as NEC, Fujitsu and MediaTek. We continue to maximize the 5G lifecycle opportunity and lead the industry with differentiated 5G solutions.

In addition, the success of our application layer strategy is reflected in the strong demand for new technologies such as O-RAN and business expansion in new end-to-end verticals. Our ability to provide complete solutions for network protocol test, security and visibility is enabling us to solve many challenges across the industry.

In another area of disruption, we continue to advance our long-term initiative to enable the quantum revolution. We are growing our quantum engagements with key customers worldwide. We also expanded our quantum solutions portfolio this quarter with the acquisition of Quantum Benchmark, which brings deep expertise in the performance validation software for quantum computing.

Keysight's software-centric solutions in higher value services continue to drive differentiation and recurring revenue growth. For the second quarter in a row, software and services each delivered double-digit order and revenue growth. Beyond innovation, execution and financial discipline, Keysight's culture has long embraced Corporate Social Responsibility. We believe our focus on climate and diversity provides us with a competitive advantage.

We recently published our annual CSR report, which includes progress towards our prior goals and the announcement of our commitment to achieving net zero emissions in the company operations by 2040. We are working to set interim science-based targets to ensure our progress towards this goal. Diversity and inclusion are also embodied in our Keysight Leadership Model.

As a CEO priority, we have specific goals and actions that will be tracked by our leadership team and the Board of Directors. Diversity and inclusion brief will be published this month that describes our longstanding D&I philosophy as well as the details of our strategies and goals. While there is more work to do, Keysight remains steadfast in our commitment to CSR and building a better planet. As we look ahead, we are encouraged by the strong demand for our differentiated solutions, while managing the longer lead times in component availability constraints.

Our in-house high performance semiconductor fab and the strength of our order fulfillment team are helping us manage these near-term supply challenges and give us confidence in our ability to navigate them entering the second half of this year.

In summary, Keysight is enabling disruptive innovation across multiple waves of technology, with a decades-long runway ahead of us. Our execution in the face of many dynamic challenges this past year is a testament to the Keysight Leadership Model, our employees and the breadth and depth of our customers.

Now, I would like to turn it over to Neil to discuss our financial performance and outlook in more detail.

Neil Dougherty - Senior Vice President, Chief Financial Officer

Thank you, Ron. And hello, everyone. As Ron mentioned, the Keysight team delivered another outstanding quarter and better-than-expected results as robust demand for our differentiated solutions and continued macro recovery resulted in strong growth across all regions.

Second quarter revenue of $1.221 billion was above the high end of our guidance range and grew 36%, or 33% on a core basis, versus a soft compare due to COVID-related disruption. Q2 revenue growth was driven by broad strength across all markets and geographies, as the Keysight team navigated macro dynamics and supply chain constraints. We achieved second quarter orders of $1.332 billion, up 22%, or 19% on a core basis.

Turning to our operational results for Q2. We reported gross margin of 64%, which increased 170 basis points. Operating expenses of $467 million were well-managed, resulting in operating margin of 26%. As discussed last quarter, variable pay expense increased approximately $30 million sequentially as a result of higher revenue growth and operating margin.

We achieved net income of $270 million and delivered $1.44 in earnings per share, which was above the high end of our guidance. Our weighted average share count for the quarter was 187 million shares.

Moving to the performance of our segments. Our Communications Solutions Group achieved second quarter revenue of $877 million, up 34%, while delivering gross margin of 65% and operating margin of 25%. Commercial communications orders and revenue in the second quarter were all-time highs. Revenue of $606 million increased 30% driven by continued investments across the 5G lifecycle. Aerospace, defense and government revenue of $271 million grew 46%, resulting from strong demand across all regions, primarily in the US and Asia Pacific, followed by a strong recovery in Europe.

The Electronic Industrial Solutions Group generated record revenue of $344 million, up 42%, or 37% on a core basis. Order and revenue strength was notable across all regions, particularly in Asia-Pacific. Semiconductor, general electronics measurement and automotive solutions orders and revenue all grew strong double-digit. EISG reported gross margin of 64% and operating margin of 28%.

Moving to the balance sheet and cash flow. We ended our second quarter with approximately $2 billion in cash and cash equivalents and reported cash flow from operations of $402 million and free cash flow of $369 million, or 30% of revenue. Our capital allocation priorities are unchanged and are focused on investments in organic growth, value-creating acquisitions and share repurchases. Under our share repurchase authorization, during the quarter, we acquired 1.59 million shares on the open market at an average price of $138.36, for a total consideration of $220 million.

Now, turning to our outlook and guidance. We expect third quarter 2021 revenue to be in the range of $1.205 billion to $1.225 billion, which represents 20% revenue growth at the midpoint. We expect Q3 earnings per share to be in the range of $1.39 to $1.45 based on a weighted diluted share count of approximately 187 million shares.

In closing, we are entering the second half of the year with strong momentum. We are pleased with our operational execution and remain confident in our ability to drive growth and deliver on our commitments.

With that, I will now turn it back to Jason for the Q&A.

Jason Kary - Vice President, Treasurer and Investor Relations

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

Question & Answers

Operator

[Operator Instructions] Your first question will come from Mehdi Hosseini, Susquehanna. Please go ahead.

Mehdi Hosseini - Susquehanna - Analyst

Yes. Thanks for taking my question. Neil, both the segments, CSG and EISG, had sequential increase in revenue, but operating margin declined. Can you elaborate is that due to the ongoing COVID cause and what else is impacting? And then, where are we in the evolution of millimeter wave and when is Keysight's expectation for the millimeter wave to go from like R&D into full production? Thank you.

Neil Dougherty - Senior Vice President, Chief Financial Officer

Yeah, Mehdi. Hey, thanks for the question. So, yeah, you're correct. And as I had indicated last quarter, we were expecting a very sizable sequential increase in our variable pay expense in Q2 relative to Q1, given that one of the primary drivers of that payout is organic revenue growth. And we had the soft revenue comp a year ago because of the COVID disruption. So, we saw about a $30 million sequential increase in variable pay as a result of that.

And then, I'll hand it over to Satish and he can address your millimeter wave question.

Satish Dhanasekaran - Senior Vice President, Chief Operating Officer

Yeah. Hi, Mehdi. As we have said before, millimeter wave is a long-term opportunity for Keysight. We're already seeing a pretty steady business for millimeter wave offerings from our customers for the past few years. So we expect it to continue to grow. Again, we're on the front end of something that's going to play out over the next decade because of the progression in millimeter wave spectrum from 20 to 40 to 70 to 90 gigahertz and then with 6G coming in with terahertz. So there is a big long-term roadmap that's playing out.

Specific to your question on 5G, maybe I can offer a data point. If you think of the certification being a critical parameter for 5G devices, about 150 devices are being certified right now, about 30% of them have millimeter wave in it. So, that paints the picture hopefully. And the total number of 5G devices right now that are being leased is about 700. So it sort of gives you maybe a framing on where we are. It's still very early days.

Mehdi Hosseini - Susquehanna - Analyst

Thank you.

Operator

Next question will come from Samik Chatterjee of JPMorgan. Please go ahead.

Joe Cardoso - JPMorgan - Analyst

Hi. Yes. This is Joe Cardoso on for Samik Chatterjee. I just wanted to follow-up on the last question, particularly around the supply chain issues that have been impacting companies industry wide. I guess, just a clarification on my part, in this quarter, did you see an impact from supplying issues on your top-line and margin? And if so, what was the impact? Can you quantify the impact? And then, relative to the guidance, are you guys baking in any headwind - material headwinds on the top-line or margins? Thank you.

Ron Nersesian - Chairman, President and Chief Executive Officer

Hi. This is Ron. As you know, in the last quarter, we exceeded our revenue guidance and you've seen our guide for the next quarter. Very pleased with the performance and how we've been able to deliver the revenue despite what's going on in the world. Of course, we see some COVID manufacturing, decreases in capacity as well as some supply chain component shortages. However, we planned ahead. We thought for those. And the most important part is that when you look at customized feeds, which have a very, very long lead time for many folks in the industry, we have an onsite fab that creates and produces all of our custom ICs. So that enables us to basically have complete control of that supply chain for the critical custom parts.

We're very confident in the guide that we have, but there's no doubt that we have built backlog and our order book is strong. So, as the world situation unravels, we could increase revenue even more and more in the future.

Operator

Next question will come from John Pitzer of Credit Suisse. Please go ahead.

John Pitzer - Credit Suisse - Analyst

Yeah. Good afternoon, guys. Congratulations on the strong quarter. Ron, I'm just kind of curious, with the recent C-band auctions in the US now behind us, can you help me better understand how that kind of impacts your view on your comms business as we go throughout the balance of this year? And as you do that, I'd be kind of curious as to the sort of geographic distribution, specifically as you think about next quarter and beyond, how much more important is China or are you actually starting to think - to see things percolate in the US and beyond?

Ron Nersesian - Chairman, President and Chief Executive Officer

Yeah. John, it's a great question. With regard to the deployment scenarios globally, as we all know, China started to lead the 5G deployments. And with the C-band auction coming in, the major announcements from the US operator referencing a roadmap to deploy more 5G in the country, we view it as a positive. We saw an uptick of our - in our business in the US, specifically for capabilities in the C-band this quarter. And we view the funnel and pipeline to be strong there. But again, not to get too siloed on one spectrum because at the end of the day, our customers are looking to test for creating devices and products that cater to the global marketplace. And right now, we have 9,000 different band combinations that our customers have to test for eventually and today they're testing 2,000. So - and we are enabling all our customers were staying in the lead and we feel good about our position there.

John Pitzer - Credit Suisse - Analyst

And then, just quickly, Neil, on the variable comp, was this quarter a particularly sort of step-up quarter? And how do we think about kind of the growth in variable comp from here as you guys continue to execute?

Neil Dougherty - Senior Vice President, Chief Financial Officer

Yeah. So, I mean, this quarter wasn't unusual, obviously we delivered 36% revenue growth. That's the total. There was some that was inorganic. But with those high levels of revenue growth, it drives our variable compensation towards the high end of what is possible. I think, as you look forward to next quarter, we still have a reasonably soft comp. We're guiding into the kind of low 20% range, which is still quite aggressive growth and it's going to see variable comp high again in Q3, not quite as high as Q2 but still quite elevated. And then we start to get to more normalized comps during the [Technical Issues] and a little bit more of a return to normalized levels.

John Pitzer - Credit Suisse - Analyst

Perfect. Helpful guys and congratulations.

Neil Dougherty - Senior Vice President, Chief Financial Officer

Thanks very much, John. And please note that the comp that we're talking about, the variable comp is for all employees in Keysight. And that is paid, one big factor is revenue growth. And you saw revenue growth number, which is driving that near the extreme limit.

Operator

Your next question will come from John Marchetti of Stifel. Please go ahead.

John Marchetti - Stifel - Analyst

Thanks very much. I was wondering if you could just comment a little bit on the Malaysian operations that you guys have obviously with some of the surges that we're starting to see, particularly in Southeast Asia if there's concerns there on your side that you may have to slow some things down there from your own manufacturing standpoint?

Ron Nersesian - Chairman, President and Chief Executive Officer

No. Our manufacturing is very well distributed. We have the largest test of measurement factory in the world in Penang, Malaysia. But we also have facilities that do develop in early production runs as well as produce certain products in Europe as well as in the US, but the bulk of it is overseas. We don't manufacture anything of scale in China so that's not an issue to us. And Padang seems to be in very good position to capitalize on any type of regional shift.

John Marchetti - Stifel - Analyst

Got it. And then, maybe just a quick follow-up regionally. When we think of the China business overall, you mentioned some of the uptick on the semi side as you're seeing some of the increased capacity, not just there but elsewhere coming in. But any change that you've seen relative to some of the language or what's going on in China, just given the bit of exposure that you have across the portfolio there?

Ron Nersesian - Chairman, President and Chief Executive Officer

No. We actually saw strong order results and order growth as well as revenue growth. Mark will tell you a little bit more about it. We did have about three points of headwinds from wall way where this is really - the second to last quarter that we expect to have that. But despite that we had very strong order and revenue growth. And I'll let Mark our head of sales to give you a little more color.

Mark Wallace - Senior Vice President, Global Sales

Thank you, Ron. John it is another quarter where we've mitigated the impact from the headwinds as Ron said about three points during the second quarter. And we pivot to other opportunities in other customers. It really exemplifies the breadth and strength of our business as well as the investments we've made in our direct sales organization there. And we're seeing strong opportunities and growth across China in semiconductor 5G commercial space. Automotive is really starting to pick up and then general electronics as well. So, I'm very pleased with what we've seen. We've got one more quarter in Q3 with some headwinds. But the bottom line is, our business in China is strong with this broad footprint of customers.

John Marchetti - Stifel - Analyst

Thanks for the color.

Ron Nersesian - Chairman, President and Chief Executive Officer

John, I just solely like to [Phonetic] point out the fact that Xiaomi was effectively, the trade restrictions were loosened is a positive sign for us, not so much the account of Xiaomi but the fact that there is some progress that is being made.

John Marchetti - Stifel - Analyst

Got it. Thank you, Ron.

Ron Nersesian - Chairman, President and Chief Executive Officer

You're welcome.

Operator

Next question will come from Mark Delaney of Goldman Sachs. Please go ahead.

Mark Delaney - Goldman Sachs - Analyst

Yes. Good afternoon and thanks very much for taking the question. I think it's the last earnings call the company had talked about the potential for EPS this fiscal year to grow in the mid to high-teens range and through the first half of the year and with guidance for fiscal 3Q. You're tracking very well relative to that. So, help me to better understand if you're still expecting that sort of a mid to high-teens growth rate and we need to be thinking about potentially a slower fiscal fourth quarter. And so, what may be the cause of that or perhaps there's now some upside to the prior commentary around EPS growth this year?

Neil Dougherty - Senior Vice President, Chief Financial Officer

Yeah. And Mark, I don't have a specific update for you to that prior number. But obviously we exceeded the high end of our guidance range here in the second quarter. And you've seen our guide for Q3. So I think as the margin things are trending a little bit better than they were when we made that statement three months ago and - but I don't have a specific update for you at this point in time.

Mark Delaney - Goldman Sachs - Analyst

Okay, very good. I'll turn it over. Thank you.

Operator

Next question will come from Adam Thalhimer of Thompson Davis. Please go ahead.

Adam Thalhimer - Thompson Davis - Analyst

Hi. Thanks. Great quarter, guys. Hey, just quickly, there was an other expense in the quarter. Just curious what that was because it did detract from the Q2 performance it looks like?

Ron Nersesian - Chairman, President and Chief Executive Officer

Yeah. We did have a - we did a modification to our pension schemes in the Netherlands and had some settlement expense as a result as we transferred those liabilities to an insurance company.

Adam Thalhimer - Thompson Davis - Analyst

Okay. Thanks.

Operator

Next question will come from David Ridley-Lane of Bank of America. Please go ahead.

David Ridley-Lane - Bank of America - Analyst

Good afternoon. So I definitely heard you on Keysight having its own supply chain under control. Other companies may be struggling a lot more than you and placing orders ahead of time, trying to make sure that they get the equipment that they need. So I'm wondering, are you seeing anecdotally any sign of pull forward on orders or maybe companies placing the order earlier that would have influenced your strong order growth this quarter?

Mark Wallace - Senior Vice President, Global Sales

Yeah. This is Mark. No, we really didn't see any evidence of that. What we saw was some - a little bit of pent up demand from the impact of COVID last year, which we kind of expected it, somewhat offset the trade headwinds that we talked about earlier. We watch cancellations very closely. They were at a record low for the quarter. And we're seeing again this steady broad demand. So have no signs that thus far that there's any material pulling of orders.

Ron Nersesian - Chairman, President and Chief Executive Officer

And David, if I could just add on, I like your characterization of the vertically integrated supply chain. And you're potentially making us a little bit less susceptible to some of these supply constraints than maybe others are facing. As I sit and look at it, the challenges with regard to movement control and social distancing, do make it a challenge to add capacity during these times. And so, I've talked about in the past, our seasonality being more muted at least through the first part of the year. I think those things are going to really serve to keep that kind of muted seasonality in place really through the end of this fiscal year.

David Ridley-Lane - Bank of America - Analyst

Thank you very much.

Operator

Your next question will come from Jim Suva, Citigroup. Please go ahead.

Jim Suva - Citigroup - Analyst

Thank you very much and congratulations on the results outlook and all the details so far. My question is, there's lots of talk about double ordering and double booking maybe from other industries like automobiles or consumer electronics or PCs and such. Or are you building in some conservatism for some double ordering or customers that may be putting in a little more orders due to the semiconductor shortage. I'm just going to kind of see if you're building in a little bit of conservatism or simply in the test of measurement industry do companies just not double order due to the lead times in specialty configurations needed?

Mark Wallace - Senior Vice President, Global Sales

Yeah. Jim, this is Mark. As I said earlier we do watch for this and there's really no evidence. Our funnel has been very strong now for many months as we continue to supply our solutions. The results, as you've seen, are very broad-based. And unlike other industries, as you point out, oftentimes the planning associated with customers procuring some of our systems and solutions can go out many months. So it really doesn't lend itself to that sort of double booking, if you will. If you look at semiconductor as one of our stronger segments, we see activities that are a year or more out in preparation for outfitting a new fab or growing capacity. So it makes it very difficult to see any sort of hedging or double booking. And as I said before, we really aren't seeing that occur thus far.

Jim Suva - Citigroup - Analyst

That's all I got. Thank you so much.

Mark Wallace - Senior Vice President, Global Sales

You're welcome.

Operator

Your next question will come from Tim Long of Barclays. Please go ahead.

Peter Zdebski - Barclays - Analyst

Hi. This is Peter on for Tim. I was wondering if you can give us some color on how much of the double-digit order growth in commercial communications was related to 5G versus the other businesses? And in particular, if you could talk a little more on the opportunity on the application layer side on in light of some of these new deployments?

Ron Nersesian - Chairman, President and Chief Executive Officer

Yeah. So, the commercial comp strength again was broad, it covered both the wireless and wireline. So it's 5G on the wireless side and 400-gig or on the wireline side as well. We also saw some recovery in our network visibility business as enterprises are planning for return to work and are thinking about you know what that IT infrastructure spend looks like. So, those all looked favorable. So generally, a very positive dynamic.

Specific to the application layer, we identified a few areas around different end market verticals and new applications to focus on about a year ago. And that's being rich dividends. On the new application front, it's the open RAN where it's an open virtualized network, bringing in new customers and more players into the ecosystem. So we had strong demand for our solutions that we launched in Q1. And in quarter one and on the new vertical side, we gained traction with a lot of the aerospace and defense companies that are looking to invest in the DoD's 5G program. So, both those are going very well. And when we look forward and look at the funnel for both these opportunities, they are very healthy and they're very rich with customer - strong customer collaborations that are building.

Peter Zdebski - Barclays - Analyst

That's great color. Thank you very much.

Operator

Your next question will come from Rick Eastman of Baird. Please go ahead.

Rick Eastman - Baird - Analyst

Yeah. Thank you. Thanks again and good quarter to be sure. And good work by the Keysight team. Hey, just a question around maybe the backlog and maybe - let me just start for one second again, it looks like you built backlog again. And maybe my rough math says your backlog is up maybe 15% or so year-over-year. When you're provided second - or excuse me, third quarter revenue guide, is the assumption that orders or your book-to-bill will be about 1.0 or is there an assumption that you work off some backlog into that revenue guide for fiscal Q3?

Ron Nersesian - Chairman, President and Chief Executive Officer

Yeah. Hi, Rick. This is Ron. Our assumption is that our book-to-bill will be about 1. And we have strong backlog and we expect to exit Q3 with strong backlog.

Rick Eastman - Baird - Analyst

Okay. Is there is a lengthening in your backlog in terms of deliveries? Obviously another supply chain question, but is there a lengthening out or are you foreseeing some ability to clear some of that backlog in Q4 by year-end?

Ron Nersesian - Chairman, President and Chief Executive Officer

Yeah. I think the most important at this point is [Indecipherable]. I'm sorry, I did have my phone on. Sorry about that. I said I think the most important factor at this point is that we feel like we're doing a good job meeting the needs of our customers and getting them the product that they need and the timelines at which they need it. And while we're not immune to some of the supply chain constraints that are out there, I think we're doing a good job managing them. We're benefiting from having to vertically integrate supply chain and we are making investments to add capacity. Obviously our revenues are going to be up substantially year-over-year but not just because of the soft comps are up very substantially over 2019 levels as well. And we'll continue to make the investments necessary that to get products into the hands of customers.

Rick Eastman - Baird - Analyst

Got you. And..

Ron Nersesian - Chairman, President and Chief Executive Officer

It's also - Rick, it's also worthwhile to note that if you look at software and you look at services, not only do they both have great double-digit order and double-digit revenue growth. We've seen more and more ARR which is going to go into the back log and let's put it this way slow a little bit how that peels off. But it will provide a great consistency of earnings as we go forward.

Neil Dougherty - Senior Vice President, Chief Financial Officer

Yeah. And we're pointing [Phonetic] north of $1 billion now.

Rick Eastman - Baird - Analyst

Great. Great.

Neil Dougherty - Senior Vice President, Chief Financial Officer

Yes, addition to be an $1 billion [Phonetic].

Rick Eastman - Baird - Analyst

$1 billion, Okay. And then, just let's follow up here. Neil, on the guide for fiscal Q3, maybe the conversion - is the conversion margin here, which I'm kind of calculating maybe low 20%s. Is that again reflect the variable comps book here?

Neil Dougherty - Senior Vice President, Chief Financial Officer

That's correct.

Rick Eastman - Baird - Analyst

Okay. All right. Very good. Thank you. Thank you again and a tremendous quarter.

Neil Dougherty - Senior Vice President, Chief Financial Officer

Thank you.

Operator

And your next question will come from Chris Snyder of UBS. Please go ahead.

Chris Snyder - UBS - Analyst

Thank you. I want to follow-up on Satish's earlier comments, which if I heard right that companies are currently testing 2,000 bands and this is going to 9,000 bands. So, more than a quadrupling of the testing, I guess, the question is how should we think about this? What it means for industry test capacity? I assume it's not a one-for-one relationship there, but any color on that just higher level of intensity would be helpful.

Satish Dhanasekaran - Senior Vice President, Chief Operating Officer

Yeah. I think it's band combinations. But you're right that the more frequency spectrum in a heterogeneous manner that gets deployed. The test intensity goes up. And if you think of a typical device maker or companies in the O-RAN space that are putting radio and see your components together and they have to do the testing The amount of time they have to do the testing doesn't go up. And so essentially you know some of the COVID restrictions or social distancing and all that essentially means that customers have - are looking at ramping up capacity for the future, but it's a steady demand that gives us confidence in our long-term outlook for the business. That's just one dimension of capacity, the other ones being all of the complexity associated with at least [Phonetic] 15 deployments. And now, with really 16 ramping up, we have new capabilities to offer such as what you saw with our press release with MediaTek this quarter.

Chris Snyder - UBS - Analyst

Appreciate all that. And then, I guess, following up on the buyback that you guys bought back a lot more shares this quarter than has been the historical run rate. I guess, going forward, is it fair to assume that the majority of free cash is going to go to share repurchase, assuming there's no M&A? I guess, the question is, like this $2 billion cash kind of balance the right maybe go forward run rate to model and put everything access into share repurchase until M&A starts coming through until we see it when they come through [Phonetic]?

Neil Dougherty - Senior Vice President, Chief Financial Officer

I think you've seen a pretty balanced use of capital from assets. As we mentioned in our prepared comments, we've generated $1 billion of cash over the last four quarters. We spent $500 million on M&A, just under $500 million on share repurchase. And I would expect to continue to see a balance as we look to invest in the future growth of our business. I think specifically as it relates to share repurchase we've committed to at least being anti-dilutive with our buyback program. But we've proven with significant buybacks both in Q4 of last year as well as in Q2 of this year that when appropriate, we'll step up and be more aggressive.

Chris Snyder - UBS - Analyst

Thank you.

Operator

Your next question will come from Matthew Niknam of Deutsche Bank. Please go ahead.

Nick Calabro - Deutsche Bank - Analyst

Hi, guys. This is Nick on for Matt. Congrats again on the quarter. Just two quick ones. First, on free cash flow, came in really strong in this quarter. I was just wondering, if you guys could provide a little bit more color on that and kind of how free cash flow should trend moving forward? And then, just the follow-up would be, obviously some other guys - some other companies are seeing tighter gross margins because of the supply chain issues and inflation and etc. And so, what are - your margins are really stable here, is that because of the in-house fabrication? Any color there would also be really helpful. Thanks.

Neil Dougherty - Senior Vice President, Chief Financial Officer

Yeah. So, let me take those questions. First of all, with regard to our free cash, obviously we're very, very pleased with the cash generation of the business. Cash penetration was unusually strong here in the second quarter. I think there are a couple of drivers of that, one is the increasing deferred revenue balances as a result of our push into software and services and building recurring revenue. So that's a great long-term trend. Then there's one significant timing difference, which we've already talked about, and that has to do with the variable pay. Obviously we've accrued that variable pay based on what was earned here in the second quarter, but that will not hit the paychecks of our employees until Q3. And so, there'll be a bit of reversal of that over the course of a couple of quarters, because we expect accrual to be high here in the third quarter as well.

As I look to gross margin, we are seeing, in some cases, some increasing input costs. But as we've said, most of our highly differentiated ICs are manufactured in-house, I think that helps shield us. I think, long-term, if you look at our business, the push that we have again towards increasing software content, increasing recurring revenue and migration of business into selling into our customer's R&D labs, the move towards complete solutions that are more highly differentiated. All of those things are helping to drive the gross margin performance that you've seen in this business over a number of years. Right, at the time of our spin, we were in the mid to upper-50%s and now we're the mid-60%s. And so, I think we've got a lot of great momentum in that space. And as we continue to build software on our solutions portfolio, I think there's still room for further improvement.

Operator

Your next question will come from Brandon Couillard of Jefferies. Please go ahead.

Brandon Couillard - Jefferies - Analyst

Hey, thanks. Good afternoon. Ron, the striping [Phonetic] in aerospace and defense is pretty impressive. Can you just talk about how you're feeling about the durability of that current momentum and how would you characterize the degree of visibility in terms of the funnel there relative to history?

Mark Wallace - Senior Vice President, Global Sales

Yeah. Brandon, this is Mark. As we've said, we've had an ongoing focus on aerospace, defense and - aerospace defense both in the US and around the world. The orders that we saw during the quarter were very strong across Western Europe as we saw increased program funding. Business in Asia was up. We had several strategic wins as was mentioned earlier for 5G. So, the long-term growth drivers are really remaining in place around the whole defense modernization with space and satellite with the addition of 5G. And we are continuing to see our funnels continue to grow as these investments continue. So, growth across multiple regions and strengths in the next-generation technologies as there are going to be deployed over really many years.

Brandon Couillard - Jefferies - Analyst

One more important question, out of…

Ron Nersesian - Chairman, President and Chief Executive Officer

If I can..

Brandon Couillard - Jefferies - Analyst

Yeah. Go ahead.

Ron Nersesian - Chairman, President and Chief Executive Officer

One more point to Mark. Biden administration has just released their first path to budget for '22. And it actually points to a higher number. That combined with any other potential technology spend from the administration, we view, as a favorable dynamic.

Brandon Couillard - Jefferies - Analyst

Got you. Just switching gears, in terms of the auto market, it's been soft for a few quarters now. Do you feel like that space is finally maybe beginning to start to turn a quarter in terms of investments and sort of next-gen programs?

Ron Nersesian - Chairman, President and Chief Executive Officer

Yeah. The automotive market had a very solid quarter in quarter two. And it was driven by some return to normalcy for manufacturing. And I know that as the automotive end market production is projected to increase in the second half, that should be a favorable dynamic for the business. But consistent with what we saw even through last year, the demand for R&D offerings in auto continued to be steady. We actually saw an uptick in that, especially around EV and AV. And our funnel for the automotive EV offerings that we have is very strong looking into the second half. We just launched solutions to solidify our EV portfolio in charging test and we continue to see a long runway for those offerings.

Brandon Couillard - Jefferies - Analyst

Great. Thanks.

Operator

Thank you. And that concludes our question-and-answer session for today. I would now like to turn the conference back over to Jason Kary for any closing remarks.

Jason Kary - Vice President, Treasurer and Investor Relations

Well, thank you all for joining us today. We look forward to speaking with you at the upcoming conferences and just wish you a good day. Thank you.

Operator

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KEYSIGHT TECHNOLOGIES INC

Q2 2021

Earnings Transcript

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