Q3 2023 Keysight Technologies Inc Earnings Call
Speaker 1: Good day ladies and gentlemen and welcome to the Keysight Technologies fiscal third quarter 2023 earnings conference call. My name is Cole and I'll be your lead operator today.
Speaker 1: If at any time during the conference you need to reach an operator, please press star zero. This call is being recorded today, Thursday, August 17th, 2023 at 1.30 p.m. Pacific time. I would now like to hand the call over to Jason Carey, Vice President, Treasurer and Investor Relations. Please go ahead, Mr. Carey.
Speaker 1: Thank you and welcome everyone to Keysight's third quarter earnings conference call for fiscal year 2023. Joining me are Keysight's President and CEO Satish Dhanushakaran and our CFO Neil Doherty. In the Q&A session we'll be joined by Chief Customer Officer Mark Wallace. The press release and information to supplement today's discussion are on our website at investor.keysight.com under the financial information tab and quarterly reports. These 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 completed within the last 12 months. The most directly comparable GAAP financial metrics and reconciliations are 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. Thank you.
Speaker 1: These statements are subject to risks and uncertainties and are only valid 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. Lastly, management is scheduled to participate in upcoming investor conferences hosted by Deutsche Bank, Goldman Sachs, and Citi. And now I will turn the call over to Satish.
Speaker 2: Good afternoon, everyone, and thank you for joining us today. Keysight reported solid results in the third quarter, demonstrating the strength of our portfolio and the resilience of our financial model.
Speaker 2: We are executing on our strategy and delivering on our commitments to customers and shareholders in a challenging macro environment.
Speaker 2: My comments today will focus on three key headlines.
Speaker 2: First, we delivered another quarter of strong financial performance demonstrating Keysight's diversified portfolio, strong execution and operating discipline.
Speaker 2: Third quarter revenue was in line with our expectations, while record earnings per share exceeded our guidance range.
Speaker 2: Second, while orders came in at the low end of our expectations, we saw positives in steady customer R&D spending and continued stability in commercial communications.
Speaker 2: growth in aerospace defense and government, and growth in our automotive, EV, and AV solutions.
Speaker 2: partially offsetting incremental softness in EISG and ASIA, primarily related to semiconductor and other manufacturing.
Speaker 2: This backdrop has tempered our near-term expectations for orders and revenue. We have factored this dynamic into our outlook for Q4, while now expecting full-year EPS growth of 7%.
Speaker 2: Third, despite the near-term challenges, Keysight's diversified business, differentiated solutions, and durable operating model give us confidence in our ability to capitalize on the long-term secular growth trends of our markets as well as outperform in a variety of market conditions.
Speaker 2: Now let's take a deeper look at our third quarter results.
Speaker 2: While orders declined 15%, revenue of $1.38 billion was up 1% on a core basis and a record for the third quarter.
Speaker 2: Our differentiation and strong execution resulted in gross margin of 66% and record operating margin of 31%.
Speaker 2: We delivered $2.19 in Earnings Per Share, which was an all-time high.
Speaker 2: Turning to the demand environment, we continue to see steady investment in strategic R&D programs in commercial communications, aerospace defense and government, and automotive EV solutions.
Speaker 2: In fact, over the past year, we have seen a meaningful growth in large long-term customer commitments related to strategic programs, particularly in automotive and ADG.
Speaker 2: We view this as an important validation of our strategy. It puts us in a strong position in key emerging technologies and positions as well for future growth.
Speaker 2: Demand was incrementally weaker in Asia this quarter as customers deferred manufacturing-related spending in semiconductor, general electronics, and automotive markets, in many cases well into next year.
Speaker 2: Turning to our business segments, Electronic Industrial Solutions Group revenue grew 14% to another quarterly record and the 12th consecutive quarter of double-digit revenue growth.
Speaker 2: The strong financial performance was driven by double digit growth across all markets and regions.
Speaker 2: The EISG orders in the third quarter trended lower, particularly in semiconductor and manufacturing.
Speaker 2: Our customer engagements remain high as they plan for and continue to invest in key long-term strategic initiatives.
Speaker 2: In Semiconductor, despite a near-term pullback in capital spending for wafer capacity, the industry is marching forward in planning for a strong future demand environment.
Speaker 2: In the near term, customers are prioritizing new applications, such as silicon photonics, to address the AI demand.
Speaker 2: As a result, this quarter we did see significant slowdown in our new wafer test solutions, while demand for Keysight's silicon photonics test and proprietary interferometer systems remained high.
Speaker 2: We expect these dynamics to continue over the next few quarters.
Speaker 2: In automotive investments in EV and AV technologies continue to be strong. This quarter, we secured a third strategic win with another large European OEM to supply an EV battery test system that includes our Pathwave Lab Automation software.
Speaker 2: This program will be implemented in 2025 and we're quite excited to be working with industry leaders and supporting their goals. Marry, Kong, Wonder great for you?
Speaker 2: to address customer needs for wireless tracking, diagnostics, and connected vehicle communications. Keysight also announced support for automated RF testing for auto-talk CB2X chipsets on our Pathwave Test Executive software platform.
Speaker 2: In general electronics, the growing collaboration between universities and companies is driving further investment in our solutions for advanced research. We're also expanding on our customer engagement in visual health solutions to support the growing digitization and connectivity requirements of this industry.
Speaker 2: Turning to Communication Solutions Group, revenue declined 5% while the overall stable demand environment continued quarter to quarter. Aerospace defense and government revenue grew 11% with strong demand from US, government, and primes.
Speaker 2: Keysight's differentiated signal generation and threat scenario emulation capabilities led to a large U.S. Air Force contract in Q3.
Speaker 2: We also want a key contract from leading Canadian prime contractors for Electro-Magnetic Spectrum Operation Applications.
Speaker 2: In addition, the demand for our radar and defense modernization solutions grew robustly as prime contractors placed orders for systems that support their delivery goals in 2024 and beyond.
Speaker 2: Government Research Demand and Investment in 5G and 6G continued as well.
Speaker 2: Commercial communications revenue declined 12% due to cautious spending by customers and weaker manufacturing activity in smartphone, PC and component supply chain.
Speaker 2: Customer engagements remain strong with R&D investments in key technology to support 5G and 6G, AIML driven, high-speed data center networking, and satellite communications.
Speaker 2: Demand for our wireline applications improved sequentially, driven by cloud provider and hyperscaler investments as they designed their networks for AI and ML workloads.
Speaker 2: enterprise customer and key service provider investment was steady, driven by increased digitization, heavier network loads, and rising cybersecurity concerns.
Speaker 2: In wireless, 5G standards are progressing and we saw steady R&D investment in Open RAN, satellite, non-terrestrial networks, and 5G REDCap Release 17 capability targeted at industrial and IoT applications.
Speaker 2: Early 6G engagements continued this quarter. We enabled the University of Stuttgart to advance 6G integrated circuit research with our sub-terrahertz solutions.
Speaker 2: T-SITE also led the agreement between the 6G Sandbox Consortium and the European Space Agency to further research to integrate terrestrial 5G-6G technologies and satellite networks of the future.
Speaker 2: This quarter, we continue to strengthen our technology leadership in the industry and enable our customers' innovation. For example, we extended our flagship network analyzer portfolio by introducing industry's first integrated platform with vector component and analysis capabilities for power amplifiers.
Speaker 2: multi-speed Ethernet performance platform supporting data center interconnects up to 800 gigabit Ethernet that are critical for data intensive applications such as AI.
Speaker 2: And lastly, Keysight enabled 3GPP protocol conformance validation for release 17 non-terrestrial networks and is continuing to partner with new satellite operators like Skylo to accelerate the deployment of satellite networks.
Speaker 2: Software and services remain an integral part of our solution strategy and again accounted for one-third of total company revenue.
Speaker 2: Overall, Software and Services revenue grew year-over-year reflecting the continued expansion of our software-centric solutions.
Speaker 2: We remain confident in the long-term secular growth of software-intensive R&D applications, particularly earlier in our customers' development process.
Speaker 2: in line with the strength and the software system simulation opportunity that I laid out at our March investor day
Speaker 2: This quarter, we announced our intent to acquire ESI Group, a leader in virtual prototyping solutions for the automotive and aerospace markets.
Speaker 2: The addition of ESI broadens our software capabilities into physical simulation and furthers our strategy of moving upstream into earlier stages of our customers' design cycles.
Speaker 2: Keysight's technology leadership and deep collaboration with industry players remains a significant competitive advantage.
Speaker 2: Despite current macro uncertainty, we see continued investments in R&D driven by multiple waves of technology innovation and broad-based industrial digitization and connectivity needs.
Speaker 2: While continuing to invest in these long-term secular growth trends, we remain disciplined and have driven incremental cost efficiencies throughout the organization this year. Our current guidance expectations are to finish the fiscal year 2023 with 7% EPS growth on 1% revenue growth.
Speaker 2: We believe this financial performance exemplifies the strength of Keysight's differentiated first-to-market solutions portfolio, our durable and resilient business model, and our winning culture which altogether positions us well for continued market outperformance.
Speaker 2: With that, I'll turn the call to Neil to discuss our financial performance and outlook.
Speaker 3: Thank you, Citech, and hello everyone. We delivered solid financial performance in Q3. Revenue of $1,382 million was just above the midpoint of our guidance range, flat year over year, and up 1% on a core basis.
Speaker 3: Orders of $1,244,000,000 declined 15% on a reported and core basis.
Speaker 3: We ended the quarter with $2.3 billion in backlog.
Speaker 3: Turning to our operational results for Q3, we reported gross margin of 66% and operating expenses of $478 million, resulting in record operating margin of 31%.
Speaker 3: We achieved net income of $393 million and delivered record earnings at $2.19 per share. Our weighted average share count for the quarter was 179 million shares.
Speaker 3: Moving to the performance of our segments.
Speaker 3: Our Communications Solutions Group generated revenue of $918 million, down 5% on a reported and core basis.
Speaker 3: Commercial communications revenue of $611 million declined 12 percent, while aerospace, defense, and government revenue of $307 million was up 11 percent, driven by increasing defense budgets worldwide and investments in technology modernization.
Speaker 3: Altogether, CSG delivered gross margin of 68% and record operating margin of 30%.
Speaker 3: The Electronic Industrial Solutions Group generated record revenue of $464 million, up 14% or 15% on a core basis.
Speaker 3: with double-digit revenue growth in automotive, general electronics, and semiconductor.
Speaker 3: EIC reported gross margin of 62% and operating margin of 34%.
Speaker 3: Moving to the balance sheet and cash flow.
Speaker 3: We ended our third quarter with $2.6 billion in cash-in-cash equivalents, generated cash flow from operations of $241 million, and free cash flow of $196 million, or 14% of revenue.
Speaker 3: Share of purchases this quarter totaled approximately 930,000 shares at an average share price of $162 for a total consideration of $151 million.
Speaker 3: Now with regard to our outlook.
Speaker 3: Exiting the corridor, and as Satish mentioned, the demand environment was mixed with areas of stability and growth, partially offsetting pockets of incremental softening.
Speaker 3: In addition, the composition of our order mix has changed over the past year.
Speaker 3: Our ability to deliver differentiated solutions and innovate at the pace of our customers has resulted in meaningful growth and strategic long-term customer commitments which will deliver high quality revenue over multi-year periods.
Speaker 3: These commitments were approximately 2% of orders in Q3 year-to-date last year and are approximately 8% of orders year-to-date this year.
Speaker 3: Turning to our fourth quarter guidance, which incorporates these factors, we expect revenue to be in the range of $1,290,000,000 to $1,310,000,000.
Speaker 3: Full year revenue at the midpoint of our guidance is $5.5 billion, representing 1% growth.
Speaker 3: We expect Q4 earnings per share to be in the range of $1.83 to $1.89 based on a weighted diluted share count of approximately 179 million shares.
Speaker 3: Full year earnings per share at the midpoint of our guidance is $8.19, representing 7% growth.
Speaker 3: As we look to next year, with the capitalization of R&D, the pending increase in the GILTI tax rate on offshore earnings, and efforts by the OECD to establish a global corporate minimum tax rate of 15%, we now estimate that our non-GAAP tax rate beginning in fiscal year 2024 will be in the range of 15 to 17%.
Speaker 3: With that, I will now turn it back to Jason for the Q&A. Thank you, Neil. Thank you, Jason.
Speaker 1: I will now turn it back to Jason for the Q&A. Thank you, Neil. Cole, will you please give the directions for the Q&A?
Speaker 4: Of course, if you would like to ask a question, please press star followed by one.
Speaker 4: We ask that you please limit yourself to one question with one follow-up question.
Speaker 4: To withdraw your question, please press the pound sign. Please hold while we compile the Q&A roster.
Speaker 4: Our first question comes from the line of Samik Chatterjee with JP Morgan.
Speaker 4: Your line is now open.
Speaker 4: is now open.
Speaker 5: Hi, can you hear me?
Speaker 5: Yes, we can hear you. Hi, can you hear me? Yes, we can hear you. If we can start with CISG, where you said demand trends or order trends are stable, maybe if we can dig into that a bit more because there have been concerns given that the smartphone ecosystem still remains.
Speaker 5: really sort of below average in terms of demand that there could be further weakness there. What are you seeing in terms of wireless versus wireline? Particularly interested in understanding if you're seeing any demand uplift from all the optics and the AI applications on the wireline side. Just maybe, well.
Speaker 2: dive into that a bit more and have a follow-up. Thank you. Sure, Samik. Let me just start by saying the Keysight team executed very well under these conditions and you see that reflected in the strong quarter and year-to-date performance. Based on our guide, we expect to deliver 7% EPS growth for the year.
Speaker 2: the orders, obviously the orders were down 10% year over year in Q2. And when you look at our orders right now for the quarter that we reported, we're down 15. A big part of that decline year over year came from our Greater China operations, which were associated with a slowdown in production, which impacted the EISC.
Speaker 2: again, we think it's transient. And I want to stress that based on all of the customer engagements, including the fabs that we engage with, they continue to believe that this is a temporary situation that is playing out.
Speaker 2: Now, I also want to sort of elevate this to a reasonable perspective because it will get at the core of your question. Our Americas business grew this quarter on top of a record Q3 a year ago and Europe was stable driven by strength in EV and AV.
Speaker 2: And again, I'll go back next to the segment perspective. Commercial communications continue to be stable and I'll get a little bit into the different segments. Aerospace and defense grew and EISG, as I mentioned before, incrementally declined. From a commercial communications perspective, 5G investment.
Speaker 2: we still are yet to see any uptick in the manufacturing business associated with the components. And that's correlated with your smartphone declines in the smartphone, in general smartphone volumes. But I think the driver here is the premarization of the smartphone market, right?
Speaker 2: back and pull the trigger on investments with regard to their innovation needs in R&D. And this is again reconfirmation of some of our base case thinking that the R&D investments are much more robust and our customers don't want to get behind.
Speaker 2: investments with regard to their innovation needs in R&D. And this is again reconfirmation of some of our base case thinking that the R&D investments are much more robust and our customers don't want to get behind. On the Waterline side...
Speaker 2: The dynamics were influenced by AI as a number of hyperscalers starting to look at the AI through the lens of AI, their investments in data center. We started to see some uptick in investments in 800 gig. Again, very preliminary, I don't want to draw too far conclusions. One quarter doesn't make a trend.
Speaker 2: And I also think the breadth of Keysight's portfolio and the contributions we're making end to end to the communications ecosystem is enabling us to outperform, I would say, our network and security business or network and application security business, which was formerly XSIA Business. Thanks a ton.
Speaker 2: has also been holding up pretty well through the year, and I believe we're continuing to take share.
Speaker 5: I'll wait for the second part of your question.
Speaker 5: Yes, please. Thank you. Thanks for that. For thinking in relation to orders and if orders – your thoughts on what we need to see in terms of orders going into next year for Keysight to be able to get back to the long-term growth outlook that you have on the revenue side..
Speaker 5: particularly in relation to I think historically your orders and revenues have been pretty tightly correlated. So how you're thinking about what you need on terms of orders and maybe one thing to clarify is I didn't really fully comprehend the implication of what Neil is mentioning in terms of more long-term strategic orders from your customers.
Speaker 5: Is that necessarily a divergence between sort of what you would see on order trends versus that translating into revenue next year? Any thoughts on that, please? Is that necessarily a dominance in your sense ofensing positive data into a genuine system of
Speaker 2: Well, I'll just make some high-level comments. First is, you know, the successes we're having in this environment is a function of execution, but also a function of the breadth of the company and all the different end markets we serve. Obviously, we don't control the macro, but we're able to figure out where there are strengths and we're able to maximize such as in aerospace.
Speaker 2: I'll just let Neil speak about the guide and the comments he made about our system integration business and associated revenue implications there.
Speaker 3: Yeah, hi, thanks, Samik. Yeah, so as you think about orders, obviously, through the first three quarters of this year, we've been able to run revenues at a level that was materially higher than the incoming order rate as we work through some of the backlog that we built up over the COVID period of time and then the supply chain disruptions.
Speaker 3: of the last 12 to 18 months. And as we look forward, we've seen this degradation in the demand environment this quarter that is going to put some pressure on orders as we move into Q4 and likely into Q1. And so our ability to continue to drive revenue based on backlog.
Speaker 3: year. That's the rate at which revenue of outpaced orders. And then I talked about this change in mix towards longer dated systems. So there's a small portion of our business which we haven't talked about much because it's been consistently less than five percent where we're working on larger scale strategic programs that are delivered.
Speaker 3: over an extended period of time to our customers. And we view it as very positive that our customers are continuing to invest in those kinds of projects. That portion of our business was roughly 2% of orders through three quarters last year. It's about 8% of orders through three quarters this year. And what that essentially means is in addition to the...
Speaker 3: $300 million, a backlog we've burned, we've taken another $200 million of short dated backlog and turned it into long dated backlog. And so as you think about our guidance for 4Q4, it's essentially built on the scheduled backlog that we have set to deliver into next quarter.
Speaker 3: and our own view of orders for the coming quarter and our ability to turn a portion of those orders into revenue within Q4. Yeah, Samik, I think just to add to what Neil said, you know, this $200 million that Neil referenced, roughly, these are high quality customers making long-range commitments, further validating the
Speaker 2: that's looking to us to provide more comprehensive solutions and systems. And in the automotive application, especially with regard to EV and AV, we're offering total solutions including power management and software for workflow automation and all of those take time.
Speaker 2: for us to complete those projects in tandem with their bring ups of their gigafactories. So they're highly coordinated, highly strategic to the customers, and I view this as giving us a further penetration with new applications, supporting our long term growth rate.
Speaker 5: Thank you. Thanks for taking my questions. Thank you, Sumik.
Speaker 4: Our next question is from Mehdi Houssini with SIG. Your line is now open.
Speaker 6: Thanks for taking my question and two for me. This is a follow-up to your commentary to the prior question. I just want to get a better understanding especially in terms of backlog normalization. It's good to hear of strategic orders longer term.
Speaker 6: And the inherent business is also driven by some of the R&D projects.
Speaker 6: The inherent business is also driven by some of the R&D project and in that context
Speaker 6: driven by some of the R&D projects. And in that context, should we assume that...
Speaker 6: Backlog normalization is into full gear and then your backlog could remain in a level that would start with a two zip code. And I'm not asking for an order guide, but I just want to better understand how you see what this is about.
Speaker 6: The post COVID normalization of backlog is training against some of the pluses and minuses in various parts of business and I have a follow up.
Speaker 3: Yeah, I think that's largely correct, right? I've talked over the past year about the fact that we felt like we had built four to five hundred million dollars of what I called abnormal backlog and as I just stated we burnt through 300 million of that through three-quarters of this year.
Speaker 3: and then we've essentially converted another 200 million of essentially short-dated TURNs backlog into backlog for these long-dated programs. So I view that we've materially worked through that abnormal backlog at this point, and I don't think it's unrealistic to assume that in this environment our kind of normalized backlog level will have a two-hand. programmes btw Diet and Builder By
Speaker 2: for us, again reflecting the strength of our customer relationships. And so the deferred balance is also a factor that is elevated that leads to the two zip code calculation you have.
Speaker 6: Okay, great. And my follow-up has to do with the semi-mix. I think you mentioned that the semi-bookings or the orders were weak in the quarter. Is that due to the delayed ramp of tape outs for 3 nanometer? And if that's the case, should we assume a rebound in semi-related orders as we start with the new fiscal year, fiscal year 24?
Speaker 2: Yeah, Mehdi, I think what you've probably seen public announcements from major FABs around pulling back of vapor capacity. So some of the investments associated with our parametric test systems, which typically feed the FABs.
Speaker 2: have been pulled back, especially around legacy technologies and memory applications. So as that rebounds, you can expect that capacity to rebound. Again, this is an area where we have good customer visibility, given long-standing relationships that we have had. But it's also a tale of two worlds, because the same customer base...
Speaker 2: is focused with us relentlessly about the advanced node development, about new application areas such as silicon photonics, which in today's world translates to AI. And we also have another business that we've talked about in the past around making interferometer systems.
Speaker 2: for two nanometers sort of technologies, and there, there is no change in demand because we are working with customers on enabling this technology. So yeah, there is a pullback in the near term, but again I want to stress this is temporary and transient.
Speaker 2: nanometers sort of technologies and there is no change in demand because we are working with customers on enabling this technology. So yeah, there is a pullback in the near term, but again, I want to stress this is temporary and transient. I just want to understand what.
Speaker 6: increase three nanometer tapeout next year have a positive impact for your semi-business. I'll have Mark Wallace take that.
Speaker 7: Yeah, hi, Maddy. What I can say is that despite the pullback in the short term, the engagement with our customers on advanced process technologies, including 3 nanometer, 4 nanometer, 2 nanometer have continued. And many of these customers are looking at a variety of aspects of their market as well as
Speaker 7: managing their financials. A couple examples, one is we have a customer in the U.S. that has delayed some of the fab build-out because of construction issues, so we expect that to correct itself in the next couple of quarters. We have another customer, again, working on these advanced node sizes and technologies who has locations in the U.S. and in Asia.
Speaker 7: and they're maintaining their total project plan and investment, but spreading the capex over several quarters. And there's a lot of those stories. So it really feels to me like we are going through a phase of pullback, but the answer to your question is, yes, we expect this.
Speaker 4: Our next question is from Aaron Rakers with Wells Fargo. Your line is now open.
Speaker 4: Thanks for taking the questions. Neil, I apologize to go back to this, but I want to be clear what I am hearing from you guys. It sounds like, Neil, you believe that backlog.
Speaker 4: coming out of this quarter is basically near normalized levels, in your opinion. And I guess what I'm really asking is that if I look back over the past couple of years, appreciating that there's some variables with COVID and everything else involved, but it looks like seasonally you typically see a sequential increase.
Speaker 4: in your order growth in fiscal 4Q. I guess, as I look at that, are you expecting sequential or how would you characterize seasonal growth in orders, or maybe rather discuss it on a book to bill basis embedded in your expectation for the fiscal fourth quarter at this point?
Speaker 3: I apologize for the confusing question, but I'm just trying to understand how you're seeing order growth in backlog. Yeah, no, it's a fair question. So first part, do we believe backlog has normalized? And I'd say the answer to that is largely yes. We believe backlog has normalized at this point. With regard to incoming order rates and seasonality, you're absolutely correct.
Speaker 3: Q3 to Q4, but we expect a significantly smaller sequential increase than would be typical based on weakness of the funnel that materialized during the third quarter.
Speaker 4: That's fair. So a book to bill improvement from this level is basically what you're alluding to.
Speaker 3: Yeah, I mean, I guess I would think of it as with backlog having normalized, we would expect orders and revenue to start to converge. Okay, that's helpful. And then I guess as a quick follow-up, I'm just maybe the opportunity to ask you about the ESI acquisition. You know, that would be helpful.
Speaker 4: How do we think about that as far as the strategic positioning and what expectations or what kind of targets we should be thinking about as far as that acquisition folding into the financial stories we move forward?
Speaker 2: So let me take that and Neil if you have anything to add you could. First of all I would say it's a great strategic fit, one we're very excited about. I think you've heard me describe the system simulation and emulation opportunity as a near-end adjacency to
Speaker 2: the work that we do with customers, especially as we have focused the strategy on engaging with customers early and in their R&D workflow. So the addition of ESI really is a great fit there. Financially, it's a creative tool, gross margins, it will be when we close the transaction.
Speaker 2: And we also, it will be creative to our software percentage by at least two points at the company level. And from a cultural perspective, I think it's very important as well. Here's a company that's been around for 50 years and has been involved in some of the most complex simulations.
Speaker 2: associated with crash testing and other areas. And I think by coming into Keysight, and what's exciting is the combination that can now not only provide a go-to-market capabilities that can further accelerate growth, but also...
Speaker 2: engage with customers in new applications in aerospace defense and other end markets, leveraging the deep technology expertise of ESI. So very excited by this transaction as we announced it. Thank you.
Thanks.
Our next question is from David Ridley Lane with Bank of America. Your line is now open. Thank you. I'm wondering if the shift to the longer term orders, is that driven by things that you're doing internally?
is the implementation of our solutions approach to what was otherwise markets that we had maybe served purely through the lens of products historically. I think of aerospace defense, David is an industry where we largely sold instrumentation tools and over the past few years we put focused effort to adding more value to the customer base by integrating the instruments but also layering on software.
have Mark maybe give you a couple more examples to make a drill. Well it might be just better just to lay it out because it's hard to imagine these but these are very strategic, very complex engagements with customers. So if we think about an EV or a battery test lab, you're talking about multiple racks of equipment for testing cells and modules and packs.
there's battery cyclers, there's low voltage interfaces for communication, there's a chiller to cool the batteries, then there's environmental chambers, there's safety aspects, fixturing software, project management, installation, site prepping, very, very, very, very complex business. And then the other thing that's really exciting for us is
this gets us deeper into the customer's business. As we announced in Q2, we won two new OEM sites in Q2, we won another one in Q3, and over that last three months, we have now, through the deeper visibility engagement across the R&D labs, have uncovered many other opportunities within those customers and across the ecosystem. So it also has an additive effect in terms of finding new opportunities to contribute. So that's a typical example of why it takes longer.
incremental margin is quite high. Is there something unusual about the margins in the fourth quarter this year? No, I mean, I think obviously, you know, as I've got the Q4 numbers in front of me, we typically see...
some uptake in OPEX as we move from Q3 to Q4, various factors, but I'd start with the fact that in Q3 significant portions of the population on summer holidays, spending less money as a result, and as they come back here into the fourth quarter, we tend to see a pickup.
We do expect a little bit of a sequential decline in gross margin, a lot of that driven by the implied volume reduction as well is kind of how we're getting to the numbers. Got it. Okay, thank you very much.
Thank you. Our next question is from Matthew Nicknam with Deutsche Bank. Your line is now open. Hey guys, thank you for taking the question. So A, I guess I want to just figure out relative to the order level we're at now, I know it sounds like we're going to get a maybe lower than seasonal bump.
stay at this 1.25, 1.3 billion range. And we've worked through excess backlog. You know, is it, and I don't wanna jump the gun on fiscal 24, but what I'm effectively getting at is, I don't think it's hard to see.
a pathway to maybe more negative or slightly negative growth next year. So I just want to make sure you know that if that maybe sounds reasonable and then you know just maybe secondly as we think about the EPS growth outlook obviously you're facing a pretty sizable headwind it seems like from
tax rate. And so I'm curious if there's any color you can add in terms of the margin structure and your ability to maybe you know effectively flex some of the margin, you know, upside that you've showcased in the past around COVID in times of top line pressure.
So full long-winded question, but any color you can provide would be helpful. Thanks. Yeah, so obviously we'll give you more color on FY24 here in three months, but obviously we've spent a fair amount of time thinking through it ourselves. And as you noted and as I've noted through the first three quarters of FY23, we were able to drive revenue at a level that was significantly above the incoming order.
at least right now I'm thinking about kind of the typical seasonal decline that we would see on the revenue line as we move from one period to the next.
And then I think as we look forward beyond that right now, we don't see a catalyst right now that is gonna drive a significant market recovery in the first half of the year, but I think we're looking to a recovery in the second half of the year, because as Satish has said, we believe that much of what's impacting our markets at this point is temporary in nature, right? Our commercial-
for the insurance of supply for two and three nanometer, silicon photonics, silicon carbide, all of that stuff is moving forward. And on the technology side, the R&D investments continue, right? We're going to see additional standards releases for 5G, continued investments in 6G research, AI, quantum, AV, EV, all of that stuff is moving forward.
is to maintain balance, right? We're optimistic about the long term. We're going to continue with the investments that are going to enable us to fully participate in the recovery when it happens, while at the same time relying on our discipline to drive EPS growth. We'll certainly work to offset whatever tax impacts we can, but as you noted, the tax impacts are significant.
I just want to also add that you've seen us, Matt, you've seen us stay disappointing some of the synergy work that we were starting to plan for anyway, and we've executed on that very well. And you can see here today our OPEX has been flat, even accounting for a lot of the inflation environment. He just said,
We're also remaining prudent and disciplined towards the macro situation in the short term.
That's great. Thank you both.
Thank you, Matthew. Our next question is from Chris Snyder with UBS. Your line is now open. Thank you. So, I very much appreciate that, you know, the softer orders and the backlog burn is leading to the softer sequential revenue from Q3 to Q4. But I wanted to ask about the sequential margins. You know, it seems like the guy puts margins maybe in the mid-28s, so down 250, 300. Or so basis points year on year. Sorry, sequentially. So, I'm getting like an 80% sequential decremental, which seems very...
on my page is used, you might want to, you know, with more time you might find it's not as steep as you as you've as you're calculating at the moment. I think I've highlighted the factors. We are expecting, you know, gross margins to be down sequentially Q3 to Q4. Again, volume dropping a significant portion of that.
You know, we did have in our Q3 numbers, we did have about three cents of kind of one-time effects spread across OPEX and gross margin, mostly related to some favorable one-time impacts with our healthcare plans that's not expected to repeat.
And then again, we're looking at typical sequential increases in OPEX as we move from Q3 to Q4.
I appreciate that. Thank you. And then I appreciate the guide on the tax next year for the non-GAAP 15 to 17. I just wanted to give me a housekeeping one. Is there any change in the cash tax rate when we think about 24 versus 23? Thank you.
tax, which will go into effect for us next fiscal year. So, you know, right now, too early to tell. I'll make some comments in a quarter. I'll be better able to address that.
which will go into effect for us next fiscal year. So right now, too early to tell. I'll make some comments in a quarter. I'll be better able to address that. Thank you.
Our next question is from Adam with Thompson Davis. Your line is now open. Your line is now open.
Hey, good afternoon, guys. The revenue guidance for Q4 of minus 10 percent at the midpoint, do you see both segments down? Can you just tell us how that plays out between the segments?
Just give me one second here. Yeah, we certainly see declines across both segments, which obviously for EISG, which has grown revenues pretty significantly through the first three quarters of a year is a significant change. But we do see revenues down similar levels across both segments.
offsetting some weakness in communication. Just wondering if the airspace and defense can stay as strong.
Yeah, I think you look at the security environment around the world, there is no doubt that the defense budgets are getting bipartisan priorities in the US. Look at Japan, that's also put out doubling of defense spend in the next five years. Europe raising defense spend and security spend as well.
So I think this is a business, as we've always said, harder to call on a quarterly basis, but very easy to look at the long-term trend. And our goal is to continue to outperform it. So yeah, we expect Q4 to be seasonally strong, generally with the end of the year and other sort of budgets that come open.
Thanks, guys.
Thanks, guys.
Our next question is from Meeta Marshall with Morgan Stanley . Your line is now open.
Great, thanks. Maybe first question for me, you know, you guys have talked about a lot of new kind of extension areas that you're seeing traction in, particularly on the AI side. You know, with the flat opex that you've noted, just wanted to get a sense of, you know, how you're making sure to kind of...
touch base with some of the new customers that might be entering into this space or how you're finding better leverage through channels. And then as a second question, just as a reminder on the communications group, can you just kind of lay out what you would consider as kind of rough percentages of kind of maintenance standards, so 4G or kind of existing 5G versus kind of the next gen portfolio? Thanks.
I would say we're preserving our R&D investments so we can outperform the market as it rebounds in the medium term to long term, which we fully expect it to. With regard to AI, a lot of our customers...
are launching AI projects in their own way, whether it's in silicon or in the networking side. And so there is a considerable channel leverage there for AI. Clearly the move to 800 gig ethernet that I referenced, you know, with higher interface capacity, higher bandwidth, lower power per bit, all of this are a place to our strength and our leadership there is helping us.
three dynamics, right? I would say deployments are continuing to scale. Second, globally and as that scales, the business there grows. Second one, it's really the standards progression. I would think of really 17 new use cases are driving customer need. And then the research activities around the world, around, call it beyond 5G.
because it's too early to call it 6G yet because this is the standard, but beyond 5G that exploration is proliferating. And I think it fits our strategy to address the R&D customer.
Great, thanks.
Our next question is from Mark Delaney with Goldman Sachs. Your line is now open. Yes, thank you for taking the questions. A follow-up question as it relates to 800G Ethernet and some of the AI activity you're seeing, you mentioned some orders already on that front, but you described it as still in the relatively early phases.
I think it's hard to put a timing there, but we've seen this sort of overlapping waves of technology really be the basis of our strategy, Mark, and having that exposure to both wireless and wireline is a core strength for the company, and we're seeing that play out even today, the diversity of applications that we have.
which should set us up well as that industry scales. As the hyperscalers are coming out of the economic situations in their business, and as they're starting to upgrade, they are looking at 800 gig ethernet for some of those technical reasons I just mentioned.
That's helpful, Satish. Thank you. And then on the ESI acquisition, you made some comments already that were helpful, including the gross margin accretion. I apologize if I missed this, but could you talk a little bit more in terms of what it may mean in terms of the EPS contribution, when that's integrated, and how you see that progressing over time? Thank you. Thank you.
Yeah, so obviously this is Neil. We do expect that there's some complexities of doing a public deal in France, it takes a little bit longer than typical to get the deal fully closed, and for us to then therefore begin to start realizing.