Q1 2023 Keysight Technologies Inc Earnings Call
[music].
Good day, ladies and gentlemen, and welcome to the key site technologies fiscal first quarter 2023 earnings Conference call. My name is Jason and I'll be your lead operator today.
After the presentation, we will conduct a question and answer session. If you'd like to ask a question. Please press star followed by one to withdraw your question. Please press the pound sign if at any time during the conference call you need to reach an operator, Please press star zero.
This call is being recorded today Tuesday February 21, 2023 at 130 PM Pacific time, I would now like to hand, the conference over to our host Jason Kary, Vice President Treasurer and Investor Relations. Please go ahead.
Thank you and welcome everyone to key sites first quarter earnings conference call for fiscal year 2023, joining me are key sites, President and CEO , <unk>, <unk> and our CFO , Neil Dougherty and the Q&A session. We will be joined by our senior Vice President of global sales and Chief customer Officer, Mark Wallace.
The press release and information to supplement today's discussion on our website at Investor <unk> Si Dot com under the financial information tab and quarterly reports today's comments will refer to non-GAAP financial measures. We will also make reference to core growth, which excludes the impact of currency movements and acquisitions or divestitures.
<unk> completed within the last 12 months, the most directly comparable GAAP financial metrics and reconciliations or on our website and all comparisons are on a year over year basis, unless otherwise noted 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 Val.
As of today, we assume no obligation to update them. Please review our recent SEC filings for a more complete picture of these risks and other factors as a reminder, we are hosting our 2023 Investor day on March 7th at the New York Stock Exchange Management is also scheduled to participate in the Morgan Stanley Investor.
Prince on March 8th and now I will turn the call over to Steve.
Thank you Jason Good afternoon, everyone and thank you for joining us today.
<unk> delivered an exceptional first quarter financial results posting revenue and earnings above the high end of our guidance against a backdrop of moderating demand our performance and consistent execution demand straight the resilience of our business and despite the challenging macro dynamics, we believe key.
<unk> is well positioned to build on our success and expand our leadership across our end markets.
I'll focus my comments today on three key headlines.
First we achieved strong financial results revenue was a first quarter record and grew 14% on a core basis driven by strength in both business segments and across all geographies.
We again demonstrated the durability of our financial model and delivered $2 and <unk> <unk> in earnings per share.
Second we started to see a normalization of what has been a robust and prolonged period of investment by our customers over the past two years significant demand for key site solutions resulted in a 15% compound order growth and a book to Bill of 1.09 <unk>.
As demand slows in the near term key sites exposure to multiple end markets its differentiated portfolio and our strong operating discipline positions us well to weather the current macro dynamics.
Third we remain confident in the secular long term growth trends across our markets. Our software centric solution strategy is well aligned with the needs of our customers, which we expect will enable us to outperform the market.
We look forward to providing you a more comprehensive update on our long term growth strategies and financial objectives at our upcoming Investor day.
Now, let's take a deeper look at our first quarter results orders declined 13% year over year against a strong compare of 22% growth in the last year's first quarter.
The slowing demand and business specific headwinds that we anticipated last quarter materialized largely as expected. This included the year over year impact of currency, our exit of Russia, and incremental China trade sanctions, which together contributed to a six point drag on the compare.
We saw customers exercised caution in response to macroeconomic uncertainty.
This was most notable amongst our largest customers in commercial communications, who were impacted by sharp demand decline in consumer electronics and computing segments.
They are restructuring and reassessing their near term priorities as the industry digests inventory, while at the same time maintaining investments across key strategic programs. While the duration is difficult to predict we expect these dynamics to weigh on our customers for at least the next couple of quarters.
Despite macro challenges revenue grew 10% or 14% on a core basis strong execution and operational discipline resulted in gross margin of 65% operating margin of 30% and earnings per share growth of 22%.
Turning to our business segments.
The electronics Industrial solutions group revenue grew 19% and delivered double digit revenue growth for the 10th consecutive quarter, which underscores the diversity of our industry exposure.
In automotive, we achieved record revenue and strong double digit growth across all regions.
Sales of electric vehicles continued to grow significantly in 2022 further fueling investment in EV in AAV technologies and manufacturing.
This quarter, we secured multiple strategic wins with large Oems and tier one suppliers across a breadth of applications such as <unk> autonomous driving emulation batteries and charging infrastructure design and in vehicle networks.
To strengthen our position in this market and capitalize on this growing decades long opportunity. We continue to expand our portfolio of solutions. And example is our current collaboration with GE on technologies to develop high efficiency compact battery test system to help accelerate the launch of new electric vehicles.
<unk>.
In general electronics double digit revenue growth was driven by continued strength in emerging verticals, such as digital health and Iot.
We also secured wins in advanced research as R&D investment remains robust and quantum photonics and beyond <unk>.
Semiconductor solutions revenue growth was driven by continued fab investments in new wafer capacity and advanced nodes.
While the inventory adjustments are facing demand foundries continue to execute their long term plans to globalize their production.
We see significant opportunities in this market and are investing in solutions for emerging semiconductor applications, such as silicon Photonics high power semi and millimeter wave.
Turning to our communications solutions group revenue grew 7% with growth across both end markets and all regions.
<unk> Communications revenue grew 11% on a core basis to reach a record Q1, which was driven by ongoing strategic investments and communications ecosystem.
We saw strength in <unk> R&D and deployments open ran and data center networking with increased focus on 800 gigabit and terra bit communication solutions.
These programs remain a priority and are driving demand for key sites first to market solutions.
As a trusted adviser we remain actively engaged with our customers as they adapt to the current macro environment.
We recently announced our collaboration with Qualcomm to accelerate <unk> non terrestrial network communications for broadband in remote areas.
And enabled device makers to speed development and verification of three GPP released 17 compliant designs. We continue to support the progression of standards and submitted the first three GPP and release 16 protocol conformance test, enabling new use cases, such as private and industrial networks and.
<unk> vehicles.
Investments in early <unk> is underway and key side joined forces with 16 organizations to create <unk> sandbox, a pan European Testbed for six <unk> experimentation and validation of <unk> advanced and <unk> capabilities.
Nokia recently selected key side sub terahertz testbed to validate <unk> and E band technology to accelerate R&D critical to <unk> advanced and <unk> use cases, and millimeter wave and sub Terre Haute frequency spectrum.
We also announced industries first and highest density networks cyber security test platform, which provides data center network infrastructure and cloud providers with leading 400 gigabit Ethernet security validation capabilities. These solutions reinforce our leadership across wireless.
In wireline ecosystems.
We are also looking forward to the mobile World Congress in Barcelona next week key side will be engaged with many customers and industry leaders and showcasing our solutions for advancing <unk> standards, including leased 17 and early research in <unk> and intelligent automation.
Turning to our government defense and aerospace business record Q1 revenue grew 9% on a core basis, achieving its second highest revenue quarter driven by increased U S government spending and strength in space and satellite, including new applications for non terrestrial networks.
We recently won a five year contract with U S Army, who chose key sites field Fox handheld spectrum analyzer for field use.
We expect U S government budget appropriations to ramp spending in new programs in the second half of this year. We also anticipate an increase in defense budgets worldwide and growing investments in new technologies, such as <unk> space and satellite quantum and advanced research.
Consistent with our strategy, we continue to expand our software capabilities. We recently completed the acquisition of clear soft, whose data and IP management software tools enhance our portfolio of electronic design automation solutions.
In addition, eggplants test automation platform was recently recognized as a leader by the Forrester wave.
About one third of our total revenue the growing mix of software and services is integral to the durability of our financial model.
Key sides of differentiation is a function of our software centric solution strategy collaboration with our customers and investments, we're making to ensure that we address the most challenging technology needs of today and into the future.
We are prioritizing high conviction growth opportunities to solidify our competitive position for the long term while at the same time accelerating initiatives to drive further efficiencies consistent with our financial model.
We remain committed to creating long term value for business stakeholders and positively impacting the global community.
I am proud of the key side has been named to the Dow Jones sustainability index for the fourth year in a row I would like to thank all of our key site employees for their dedication and relentless execution, which drives our strong track record of performance and is a testament to the key side leadership model, our values and to our people.
With that I'll now turn the call over to Neil to discuss our financial performance and outlook.
Thank you <unk> and Hello, everyone Q1 was a strong quarter and a solid start to the year, we delivered revenue of $1 $381 million, which was above the high end of our guidance range and grew 10% or 14% on a core basis.
As we anticipated macroeconomic uncertainty moderated demand in the first quarter orders of $1 $3 billion were down 13% or 10% on a core basis.
Even with revenue outpacing orders by $80 million, we ended the quarter with over $2 5 billion in backlog.
Turning to our operational results for Q1, we reported gross margin of 65% and operating expenses of $492 million <unk>.
<unk>, resulting in operating margin of 30%.
We achieved net income of $363 million and delivered $2 in <unk> and earnings per share, which was above the high end of our guidance our weighted average share count for the quarter was 180 million shares.
Moving to the performance of our segments, our communications solutions group generated revenue of $939 million up 7% or 10% on a core basis.
Commercial communications revenue of $629 million was up 8% with double digit revenue growth in the Americas.
Aerospace defense and government revenue of $310 million benefited from increased U S government spending, which we believe will continue to ramp through FY2023 altogether CST delivered record gross margin of 67% and operating margin of 29%.
The electronic industrial solutions group generated first quarter revenue of $442 million up 19% or 23% on a core basis with double digit revenue growth in automotive and general electronics, demonstrating the diversity of our markets.
Growth was strongest in the Americas and Europe .
ISG reported gross margin of 61% and operating margin of 32%.
Moving to the balance sheet and cash flow. We ended our first quarter with $2 $2 2 billion in cash and cash equivalents generating cash flow from operations of $366 million and free cash flow of $306 million or 22% of revenue.
Share repurchases this quarter totaled approximately 700000 shares at an average share price of $176 for a total consideration of $125 million.
Now turning to our outlook, we are navigating the same evolving macro and industry dynamics that others have noted.
As <unk> mentioned, we expect it will take at least a couple of quarters for our customers to work through their near term challenges.
If the current demand environment persists through our fourth quarter, we would expect to deliver low single digit revenue and earnings per share growth for the year achieved through steady backlog conversion strong cost discipline and the flexibility of our financial model.
Turning to our second quarter guidance, we expect revenue to be in the range of $1 $370 million to $1 $390 million in Q2 earnings per share to be in the range of $1 91 to $1 97.
Based on a weighted diluted share count of approximately 179 million shares while near term where uncertainties are moderating the demand environment key sites secular long term growth trends remain intact, our differentiated first to market solutions durability of our financial model steady cash generation and strong balance sheet.
<unk> well to deliver on our commitments to our customers and shareholders. We look forward to sharing more with you about the compounding nature of our business at our upcoming Investor day with that I will now turn it back to Jason for the Q&A.
Thanks, Neil Jason can you give the instructions for the Q&A. Please.
Yes.
Ladies and gentlemen, if you would like to ask a question. Please press star one to ask.
That you limit yourself to asking one question and one follow up to withdraw your question. Please press the pound sign.
Please hold while we compile the Q&A roster.
Our first question is from Mark Delaney with Goldman Sachs. Your line is now open.
Yes.
Good afternoon. Thank you very much for taking the question I was hoping first you could elaborate a little bit more oil.
I was hoping to elaborate a little bit more on the comments on orders. It seems like it's particularly impacting the commercial communications business and maybe certain other areas are doing a bit better, but if you could elaborate a bit more on what you're seeing.
The orders and where perhaps you're seeing some moderation from customers.
Yes, Hi, Mark will do first I want to start by saying.
Our customer engagements remained very strong and robust shipment activity this quarter and you see that reflected in the strong revenue performance.
Second our backlog is still at $2 $5 billion high quality low cancellations to date.
And to put this demand normalization in context, I would just point to two things first as we said in the last earnings call. We have some business specific headwinds roughly six to seven points that that played out.
And this quarter, our comps from a year ago, we were up 22%, so putting putting those things in context.
A little bit more deep dive I'll provide on the end markets could be could be helpful. In commercial communications.
We saw the top customer pulled back, especially in the wireless part of the business.
Due to the macro challenges and the inventory digestion that they were going through especially with regard to the smartphone industry.
We also saw equally the activity system pick up on the wireline side as customers are investing in 400 gig and 800 gig Ethernet and terabyte and beyond so those investments remained strong.
In our aerospace and defense business, we're starting to see a favorable uptick in the U S business as budgets are passed and program spend to get unlocked.
It's also important to note that the debt.
All of the Prime contractors had.
A stronger backlog positions, which also gives us a good outlook.
As we look ahead and our industrial business continues to show resilience with the research spend occurring in different countries around the world.
Automotive with EV, and <unk> and Nextgen semi investments remaining strong as well so.
We put all of this in context and say we remain confident in the in the portfolio differentiation, we have and we're actively engaged with our customers, which will enable us to outperform in this environment.
Thanks, That's very helpful. My other question was on the cost controls in the company spoke about being disciplined when you're winning more to the variable nature of your cost structure and that will moderate spending depending on what demand. Ultimately does this year or are there more specific steps that case that is planning to take on cost controls. Thank you.
Yes, Mark.
As we mentioned always that we have this variable cost structure and operating model.
The first leg of our of our resilience from a financial perspective, but we're always looking for dynamic resource allocation opportunities, especially in a market like this where we see some of our customers pullback, we redeploy to other customers who need these technologies. So that we're maximizing so thats part of that discipline that I referenced and.
We always have on deck operational efficiency programs as part of the key site leadership model.
And we're remaining focused on that in some cases, even accelerating that.
That should help us offset the inflationary impacts to the P&L as we are all faced with right now.
Thank you.
Our next question comes from Mehdi Hosseini with <unk>. Your line is now.
Thanks for taking my question I wanted to go back to.
Bookings and backlog.
These have been very clear for a couple of quarters that post COVID-19, we're going to have to go through a backlog normalization and I wanted to wanted to get some more color from you is.
Is there any way you can separate or differentiate the back log normalization from end market demand weakness, especially in the smartphone area that you highlighted.
Yes, maybe I'll just start at the Neal can add I would say that if we look at our end markets and and if you take a look at the commercial comps, especially in the wireless side. The top customer pullback is definitely macro related and related to the inventory exposure that they have which has been widely talked about.
But if we look at the base customer spend it remains pretty strong so.
So that's that's as far as that end market is concerned, but we start to look at aerospace defense and our industrial exposure.
To provide us topline and diversity.
And I think that'll play out as we go through the year as well Neal specific to our backlog position, yes, I mean.
The only thing I would add to that is it.
Maybe starting with the supply chain, we still have areas, where we our supply chain constraints, but in other areas. We've seen a pretty rapid improvement in terms of ability of availability of product and kind of.
Trend towards normalization of of lead times and so what we're what we are seeing and I've talked about this as something we expected.
In many cases, we have products for our customers for those products that have scheduled shipments now out an additional quarter and beyond and as our lead times have come in they don't know at this time need to place new orders until they get delivery of the product that's already sitting in backlog and so.
If youre wound search for eight months there was this.
Tendency to place orders early to get in line to adjust for those long lead times now that we're seeing lead times normalized and coupled with macro uncertainty there is no longer that incentive to get in line early and that is creating a little bit of additional pressure on the on the on the order line.
Sure.
Just a follow up here.
You did $1 3 billion of new orders is there any way we could think about.
The R&D portion of the order or the strategic investments that were reflected in the $1 3 billion from production and I'm just trying to better understand how we should think about that.
The downside risk in booking activity from here is there.
Is $800 million a quarter.
Worst case scenario or anything in the industry that can offer will be very helpful. Thank you.
Yes. Thank you Mehdi again, it remains highly uncertain environment as you know, we're we're seeing is customers typically firm up demand and budgets at the beginning of the year.
Because of the concerns they have they're pushing out those decisions to later in the year. So.
Certainty definitely remains but as we look at the spending environment, especially even in commercial comps, we see more pullback around manufacturing expansions relative to the R&D plans of customers. So thats thats generally the trend and if you look in the ISG business I'll say into semiconductor as an example customers or not.
Pulling back on next Gen semi capacity right, whether it's five nanometer three nanometer there actually may be cutting back on some of the seven nanometer work that they were they were planning on so the focus on next generation remains very strong I may I will ask mark to provide some color.
Some color on the customer dynamics that he is seeing in the <unk>.
From a sales perspective, yes, and I would maybe I would just.
Directly answer your question.
The mixed during the quarter was was still very predominant R&D and as <unk> mentioned, the pullback was much less there, especially in commercial comms than it was on the manufacturing side. The other factor that we've talked about in the past on other conference calls is our funnel we have a six month funnel that.
Gives us a strong indication of.
The forward looking demand.
That has been factored into our guide it has normalized with the effects that we saw pretty acutely here in the first quarter and.
Looking out six months.
The demand signal looks to be fairly consistent in line with what we saw in Q1.
Maybe the other point with regard to <unk>.
Your comment on on the downside risk right I will say that we've done a lot of work to to enter into more of the R&D markets of our customers that still remains a priority for us. We've also done quite a bit of work to diversify this business.
To expand into industrial end markets Aerospace defense and in auto in particular, and finally through the through our sales footprint. We've done work to attract new customers and that remains a critical priority for us and we which will which I remain confident that all of these actions will enable us to outperform in this environment.
As well.
Thank you.
Thank you.
Our next question is from meta Marshall with Morgan Stanley . Your line is now.
Great. Thanks.
A couple of questions.
I mean, maybe you spoke to kind of open ran millimeter wave in.
Some areas of investment I guess as we think about the communications business could you just give a sense of like what are the strongest revenue drivers growing and moving into kind of calendar year 2023 open ran is a millimeter wave <unk>.
Kind of.
What is the general strength of that business coming from.
And then maybe as a follow up question you guys mentioned, some kind of cost discipline stronger cost discipline.
You are balancing out kind of the lower demand indications from but just.
Sense of.
Where investments are still being made.
Just what degree of those cuts are we talking about as we move throughout the year.
Yes.
Meta. Thank you. So first of all we remain intensely focused on continuing to innovate and strengthen our portfolio. So from an R&D perspective. The collaborations we have with our customers informed where we invest and we feel pretty good about it at best some of these pullbacks or short term delays for R&D spend.
And we expect those to recover as our customer.
Deals with these inventory dynamics that we've mentioned.
Got to <unk>.
I would say that the R&D roadmap.
It remains in place right, our customers have a multiyear roadmap and they continue to invest to realize that road map.
And.
At the Big picture level I would say.
While substantial progress has been made in terms of <unk> deployments, we still have about roughly 1 billion subscribers in the world and the roadmap is to take it from 1 billion to $5 billion in the next five years or so so clearly there is more deployment activity occurring that's in front of us with India and other parts of the world leading that.
Effort.
The standards progression, which really is a basis for R&D business with release 16 and release 17 moving into release 18, which will be <unk> advanced.
It was pretty strong and those innovation vectors around non terrestrial networks, new features such as red cap for Iot applications.
Proliferation of <unk> into new verticals remains areas of opportunity for us that we're that we're investing in to continue to differentiate along with open ran as well, which we have talked about but the industry roadmap remains remained solid and our differentiation remains strong in these markets.
And then maybe I'll just address that.
Cost discipline question, so first and foremost I'd like to just emphasize that we are continuing our growth oriented investments that are going to drive this business forward in the future. We're very clear about what those priorities are internally and we're keeping our foot on the gas with regard to our most important growth driven investments.
He said he'd like to waste <unk> characterized it right. We always have onset of tap of efficiency gains that we're looking to we're looking to operate on as part of our continuous improvement culture and given the environment that we're in with pressure on the top line, coupled with not just inflation frankly, but signs that the.
The dollar is going to backtrack on some of the strengthening that we saw last year, which will also put pressure on our on our foreign currency.
Spending.
We felt it was prudent for us to take actions to accelerate some of that efficiency. So it's across the P&L, but we are not we're not putting future growth investments at risk.
Great. Thanks.
Our next question comes from semi Cheddar G with Jpmorgan. Your line is now open.
Yes, hi, thanks for taking my questions I guess, if I can just start with autos and if you can comment on the linearity of orders through the quarter based on your expectations of seeing some of this digestion from customer funds. A couple of quarters suggest you had more deterioration maybe as you exited the quarter, but just wanted to check if sort of what's the.
The trend through the months in the quarter that you saw and the comment that you made about electronics orders are holding up better than communication overall.
You sort of generalize overall, but.
It seems.
It seems a bit counterintuitive because my impression was that communication is a bit more R&D aligned for you than you guys in general, but maybe if you can sort of correct me there and explain why thats happening if R&D is more predictable kind of a follow up thank you.
Sure. So Mike this is mark I'll take the first question on linearity of orders and it was we had about two thirds of our orders. After the second month, we had a big finish to the end of.
FY 'twenty two in our fourth quarter.
So we had a nice rebound in December and the last quarter was about 34% of the total orders bookings for the quarter. So it was it was a pretty linear flow of business.
On the electronic industrial side, what we see as Satish mentioned.
Is continued demand around next generation process technologies for our semiconductor business very long term secular growth drivers that we've been talking about for a long time.
Activity level and focus around the.
The next generation auto easy in particular is continuing to ramp again. This is a decade long transformation. The number of Evs sold last year as opposed to ice vehicles continues to grow so I see this as a long term trend and what I was particularly.
Surprise with was how our general electronics business held up particularly around some of the verticals that we're focused on.
Digital health care Advanced research and education, obviously some of this is exposed to broader GDP kind of markets, where we saw the PMI.
Stay below 54, I think it was five or six months in a row, but in general the three segments below ISG continue to show resilience.
And overall.
Continued investments in these generate next generation technologies.
Alright, great.
For my follow up and maybe you could just change gears here a bit does a competitor of yours.
Is going through a strategic review process with interest from multiple parties for an acquisition.
Not asking you to comment on the interest in that.
Company in itself, but how should we think about benefits to key site from scaling the business and a step function from here on in the level of leverage debt leverage on the balance sheet, you would be comfortable with if attractive opportunities did come through that are more visible. Thank you.
Yes. Thank you so much.
I'd say, you're right, we don't comment on any specific opportunity I would just say that we remain confident in the business that we run.
Its cash generation potential you've seen the strong free cash flow performance of the business and so.
Congruent with that we have a consistent capital allocation.
Discipline, which is around organic growth.
And M&A, where it makes sense and return a return of capital and with regard to M&A, you've seen us be incredibly patient and disciplined with regard to the opportunities. We pursue we look at hundreds of companies after having done market assessments on them and then we've done about 20 to date and we've been.
And we've done them with a view of the strategy and what scale that we can bring to the target and how we see.
First the strategic fed, but secondly, and equally important is the return to our shareholders. So.
Those hurdles will continue to remain in place and.
We remain very disciplined.
Thank you.
Our next question is from Chris Snyder with UBS. Your line is now open.
Yes.
Thank you.
So back on the conference call in November the company talked about book to Bill is approaching a more normalized one point I'll ask.
The quarter came in a bit below that at nine four so were we.
Orders in the quarter softer than you would have expected back in November .
Scope for book to bills to improve as the year goes on and kind of reached that more normalized average of one <unk> for the full year.
Yes, I mean, if you go back to the November quarter, we talked about eight points of specific headwinds that we were facing from currency and from China, Russia, those things and that we expected.
We're also recognizing macro softness on top of that are anticipating macro softness on top of that so.
By and large I would say that the quarter came in largely in line with our expectations. It's obviously hard to put a quantification on macro I mean looking forward as <unk> said its very difficult to call. At this point, we've attempted to give you some parameters with which to think about the business Mark has commented that our funnel which looks.
Over the next couple of quarters would indicate demand thats more or less in line with what we just saw in the first quarter and then I did state in my prepared comments.
If that kind of order trends remain in place for our entire remainder of our fiscal year, we would expect to still be able to deliver a low single digit revenue and EPS growth. So we're taking it one quarter at a time, but that should hopefully give you some guardrails with which to think about the business.
Thank you I appreciate that and then just kind of staying on orders.
For fiscal Q1 is there anything or color you could provide around how orders in China did during the quarter given a lot of the disruption over there so government and defense business orders just given some of the budgeting resolution processes going on thank you.
Sure. This is Marc I'll comment on both of those so.
We faced as everyone did the unanticipated breakout from Covid and there were some incremental trade restrictions that happened in the month of December .
We did see orders decline in China, They actually increased sequentially issue that kind of indicates though the unusual seasonality that we faced.
But it was.
It was.
Relative to what we were expecting to face with some of the declines I was pleased with our response and it really continues to be in line with what we've talked about in the past, which is our ability to pivot to new opportunities in the breadth of our customer base in China, which continues to be an area of strength.
For us and that includes automotive where the business was up.
Some of the private networks, which is a new use case for <unk> from an industrial standpoint continue to show signs of growth for us.
Mature process technologies for semiconductor so as we go forward and the economy begins to normalize there and maybe reopen into the second half, we'll keep a close eye on that as well.
Space and defense.
<unk> noted in his opening comments and otherwise.
We saw.
Strong growth order growth in the U S.
That is a direct byproduct of the budget being approved much earlier this year than last year and what we see happen in Q1 was not new program starts, but rather multi year programs that we're stalled because of continuing resolution turned back on and some of that spend continue to flow so as.
As we get through the next several months and quarters and the record high our <unk> budget.
Those through the process, we hope to see some additional tailwind there.
Outside the U S with the geopolitical situation, we expect to see continued long term demand for to fund defense modernization.
So, we're we're positioned well to capture that as well.
Just maybe to add a comment too.
The space and satellite also continues to inflect for us in the aerospace defense business.
And it's showing some momentum there with customers too. Thanks.
Thank you.
Our next question comes from Aaron Rakers with Wells Fargo. Your line is now open.
Yeah. Thanks for taking the question I'm going to go back to kind of the order and backlog dynamics. Neil I think last quarter. You had mentioned that you were maybe about four or five weeks.
Kind of inflated our elevated backlog relative to normal.
I'm curious of where that stands right now and does your low single digit assumption.
<unk> growth was assumed kind of a back to normalized backlog levels through the course of the year.
Yes, it's a great question. So obviously your revenue outpaced orders by about $80 million within the quarter.
You can you can do the math on it but if we see similar environment persist for the remainder of the year, which is.
Again in line with the guard rails, what I put out there we burned 300 million plus of that of that kind of abnormal backlog. So you may not get us all the way home, but it would get us.
A significant chunk of the way towards a normalization of the backlog over a multiyear period multi quarter period, we always knew it would take multiple quarters to normalize the backlog in.
While this is just one scenario I think it's not out of line with our expectations.
Okay and that's helpful. And then a quick follow up on just on the semiconductor business you continue to perform well and I don't know the answer to this question, but I'll just put it out there is that is there any kind of disruptions I think theres been a supplier in the semiconductor supply chain that had seen I think some cyber attack issues is that at all.
<unk> impactful to your business or not.
No not at all.
For us.
We serve the wafer stage, which is on the front end. It takes a longer lead time for fabs to put capacity and we see customers sticking with their plans for five nanometer and below.
And equally we are also quite pleased with the progression were making.
Further add more applications into our into our solution strapped whether it is high.
High power applications for certain chips or silicon photonics or millimeter wave. So we continue to build that portfolio out.
Sure.
Okay. Thank you.
Our next question comes from Jim Suva with Citigroup. Your line is now open.
Thank you. The first part of my question is Neil you made the question or the statement as the year plays out if it does according to plan Youre looking at kind of sales growth I think I heard you say.
Low mid single digits, and then you said and sales and EPS growth did you mean to EPS growth to be positive or like in that same range of sales growth is typically earnings per share grows at a bigger or a magnitude about sales growth then I'll have a follow up thank you.
Yes, so what I said first of all we werent guiding the year, what we said is Thailand certain environment, it's difficult to know, but if the demand stays consistent with where what we saw in Q1 through the remainder of our year, we would expect to deliver in that scenario low single digit revenue and low single digit EPS.
<unk> growth, obviously, our model calls for higher revenue growth in that with 40% operating leverage which enables us to get to double digit EPS growth join us scenario, where revenues are growing at a lower level, coupled with this inflationary environment, which is a bit abnormal we'd be looking at low singles for both both revenue and EPS again.
Under that specific scenario, where where our orders remain more or less in line with what we saw in the first quarter.
Great and then my follow up question is I believe it was in the month of December that had the incremental trade restrictions against China, I think that's right and so when we think about your commentary for 2023, if things are consistent how much of <unk>.
<unk> impact is that incremental restrictions is that what you're referring to.
In your prepared commentary about the kind of three to four points in our 6% to seven points of growth impact or can you just help me flush out the impact of the trade restrictions. Thank you.
So the new China trade restrictions that came about in December is an additional one to two points of headwind for us over the longer term the comment about six to seven was on the call last quarter I outlined at the time, we thought it was going to be eight points of headwind coming from China, Russia and FX.
As we got to the end of the quarter, what we thought was going to be eight was more like six five so call. It six to seven and that's largely because the dollar backed up a little bit. So the FX impact was less than originally expected the China impact was slightly less as well.
Great. Thanks for the clarifications and look forward to seeing Q on March 7th.
Thank you.
Yeah.
Our next question is from Matthew unique name with Deutsche Bank. Your line is now open.
Hey, Thank you for taking the question maybe just to follow up on that last one on the analyst day I'm just wondering any initial thoughts on what we could expect on March 7th in terms of just updates too.
Longer term targets and then.
And just on the M&A backdrop I'm just wondering what's the latest you're seeing in terms of opportunities and valuations.
<unk> been focused on some smaller sized software deals I'm just wondering if that's still the focus or maybe whether youre open to larger deals just considering the pullback in private market valuations. Thanks.
Yes. Thank you.
I look forward to sharing.
The.
The forward looking view on the market fundamentally at the Investor day across our end markets. We have we see innovation accelerating and I think we'll lay out key sites strategy to go intercept those exciting long term opportunity. So that's that's number one but I think with regard to M&A clearly if you look at how we've grown we've been.
Disciplined in.
In Actioning M&A of all sizes, you've seen us do an IDE and <unk>.
Slightly larger scale and then a lot of technology tuck ins, which have helped us complete the workflow and actually create greater value for customers and also expand our margins in the process. So from that perspective, we remain.
Active in exploring new markets and.
And targets as well, but again as I mentioned before.
We have strong strategic and financial hurdles that we have to meet those gates before we go ahead and transact business.
On the valuation front.
On the margin, we think the valuations are likely to come in as as more of the market reality sets in with a number of the firms so and with a strong balance sheet and cash position.
We remain active in exploring opportunities.
That's great. Thank you.
Thank you I look forward to seeing you at the Investor day.
Our next question is from Adam <unk> with <unk>.
And Davis your line is now open.
Hey, good afternoon, guys. Congrats on the on the Q1 beat.
Hey, first question on cancellations, you said that they've been low to date I guess I just wanted to gauge your level of concern that could get worse.
We've had no increase in our in our cancellation rate. So we continue to believe the quality of our backlog is very high.
And then.
I guess I'm just curious how does this.
Downturn or what youre seeing so far compared to prior downturns.
Amazingly you guys have been public almost 10 years, but we haven't had a prolonged recession during that period.
Yes, I think.
The city sure every recessionary environment is different and I would say that.
After having a couple of very strong growth years, some normalization was inevitable and what we're seeing is pulled back from some of the customers in response to some of the inventory excesses in specific markets, but I go back to our portfolio position is the strongest it's ever been because of our emphasis on solutions our business.
Model today is much stronger because we have 30 or 33% of our business is software and services, which gives us additional resilience and we have a strong operating model.
The company that allows us to.
Tight or.
Some federal patients in the marketplace and we also entered the year with with.
With a strong backlog position as well so from those perspectives. It's different I also think if you look at the gross margin.
At the company level, we continue to stay strong at 65% and <unk>.
And I think with the operation model in place, we remain confident about our ability to.
To demonstrate that resilience.
Okay. Thank you guys.
Our next question is from Rob Mason with Baird. Your line is now open.
Yes, good evening.
Maybe I'll follow up your comment.
Weston just.
The software orders in the quarter.
Hello.
<unk> that they remain resilient, but as you think about.
Where you've seen some challenges.
<unk> communications.
To the extent that there is.
Slowdown in renewals or is that something that.
It's your radar screen as you see some of the head count reductions to take place in the tech sector, just how you defend against that.
Yes, I think we have incredibly sticky business with our customers and we're not seeing them pull back on renewals.
Obviously, new purchases are taking longer as mark alluded to earlier.
But I think even in the commercial communications sector. We have we have two businesses right wireless and wireline, we're seeing stronger pull back from customers in the wireless side of the equation the wireline customers continuing to innovate you see some of the trends in datacenter and cloud are playing out need for faster data rates is important also in.
<unk> of all of the activity that's going on around AI, there is greater need to optimize the workflows of our customers so that.
That part of the.
Opportunity continues to remain stronger on a relative basis.
Just have Mark me, Ralph just to answer yes, there was a strategic did a great job and I'll. Just let you know we didn't see the pullback in software like we did in other parts of the business as a matter of fact, our renewals were up and our growth from subscriptions and enterprise agreements remained steady which is what you would expect from a sticky business something that has.
Kind of a continuous flow of value in a subscription model so that really work for us this quarter.
Sure sure is that maybe just as a follow on question is that the influence that seems to certainly be may be a trend.
Two quarters two years make a trend.
We're the first quarter gross margin is a good bit stronger in the commercial communications segment.
And then maybe steps down moderates in the second quarter is that still the expectation of the dynamic at play there.
Could you repeat that I'm sorry.
Yes.
Essentially your communications CST group gross margins tends to have a much stronger first quarter gross margin at least going back the last couple of years.
Does the remainder of the year is that would that be the expectation this year as well.
I don't think you can draw any conclusions looking at historical sequential gross margin data as to as to what to expect.
At least as I would think about it any perturbations that may have appeared to have repeated has to be more coincidental than systematic.
Thank you.
Yes.
And our final question is from David Ridley Lane with Bank of America. Your line is now.
Good evening. Thank you.
The typical seasonality is for nice sequential uptick in ISG in the second quarter.
What are the commentary on the call it's been that ESG remains pretty strong.
Within your second quarter guidance should we expect kind of that.
<unk> sequential pattern in Es.
S G.
Yes.
All I would say is our sequential guide right now it takes a look at our large backlog it looks at the schedule of shipments looks at the incoming funnel and obviously, we're going to we're going to rely on a portion of incoming orders to turn into revenue within the quarter and.
And so we have a high degree of confidence in our ability to deliver to the number that we put out.
And then also on.
I E.
Yes, ISG excuse me.
The trend in gross margin has been a little bit softer over the last couple of quarters.
That being said margin expansion operating margin expansion has continued to be quite good.
Just wondering is there something in the mix or.
The other dynamic that you could call out to sort of explain that that gross margin trend there.
Yeah across the businesses.
We obviously looking to create value for our customers and that value expectations go up with time greater solutions content Greater software our software obviously increases the gross margin you see that in our CSD business at 67% gross margin. So we will continue to drive that up on the ISG business slightly lower software.
Content higher mix of manufacturing offerings traditionally, but equally our emphasis on creating solutions has not diminished where in fact, adding more software content even to our semi manufacturing test systems, we're providing more analysis capabilities and we have strong customer uptake for those so over time as we come off this inflationary impacts of the.
The supply chain and other things that we've talked about I would continue to expect more margin upside and look forward to sharing some of that with you at the Investor day.
Thank you very much.
There are no more questions. So I'll pass the call back over to the management team for closing remarks.
Yes. Thank you.
Thank you all for joining <unk> delivered another strong quarter of revenue up 10% strong gross margins at 65% operating profit, 30% free cash flow of greater than $300 million.
And we continue to remain focused on actively collaborating with our customer customers across the multiple end markets. We serve as they navigate these dynamic conditions, which gives us the confidence in our ability to outperform again, we have a diversified end market exposure strong solutions portfolio that's growing.
Strength of backlog strong cash position and a strong balance sheet and and all of these enable us to invest too to realize our long term growth strategies at both.
We're doing so with the fiscal discipline and prudent operational initiatives that we have in place. We look forward to seeing you all in New York on March 7th and I'm excited to share the future growth strategy moving forward. Thank you.
That concludes the conference call. Thank you for your participation you may now disconnect your lines.