Keysight Technologies Q4 2022 Earnings Call Transcript

Quartr
Provided by Quartr
November 17, 2022

There are 14 speakers on the call.

Operator

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal 4th Quarter 2022 Earnings Conference Call. My name is Dante, and I will be your lead operator today. After the presentation, we will conduct a question and answer session. This call is being recorded today, Thursday, November 17, 2022 at 2 pm Pacific Time. I would now like to hand the conference over to Jason Carey, Vice President, Treasurer and Investor Relations.

Operator

Please go ahead, Mr. Carey.

Speaker 1

Thank you, and welcome, everyone, to Keysight's 4th quarter earnings conference call for fiscal year 2022. Joining me are Keysight's President and CEO, Satish Dhanasekaran and our CFO, Neil Daugherty. In the Q and A session, we'll be joined by Senior President of Global Sales and Chief Customer Officer, Mark Wallace. You can find the press release and information to supplement today's discussion on our website at investor. Keysight.com under the Financial Information tab and Quarterly Reports.

Speaker 1

Today's comments by Satish and Neil will refer to non GAAP financial measures. We will also make reference to core growth, which excludes the impact of currency movements 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. These statements are subject to risks and uncertainties and are only valid as of today.

Speaker 1

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 in upcoming investor conferences hosted by Credit Suisse and Wells Fargo. We hope to see many of you there. And now, I

Speaker 2

will turn the call over to Satish. Thank you, Jason, and thank you all for joining us. Keysight reported strong 4th quarter results, which exceeded the high end of our And drove a strong finish to the year. Before we get into the quarter, I want to highlight our exceptional performance For fiscal year, which illustrates continued progress we're making in transforming the company to a software centric solutions provider. We set new records for orders, which grew 12% to $6,000,000,000 a new record for revenue, which was up 10% And a new record for earnings per share, which increased 22%, all the while returning capital through $849,000,000 in Share repurchases are 89% of free cash flow.

Speaker 2

In addition, we continue to invest in next generation technologies For long term differentiation and see a high level of engagement and activity with our customers around their future needs. Today, I'll focus my comments on 3 key headlines. First, we delivered an all time record revenue and earnings per share in the Q4 ahead of expectations enabled by outstanding execution by Keysight teams who successfully navigated Supply chain, geopolitical and macro dynamics. 2nd, we achieved record orders of $1,600,000,000 With steady bookings throughout the quarter and a book to bill of 1.09. While our customers' multiyear roadmaps remain unchanged, We are exercising more caution given the macro backdrop, which we anticipate will moderate demand in the near term.

Speaker 2

3rd, As we enter fiscal 'twenty three, we remain confident in our ability to outperform the market based on the differentiation of our solutions, Our strong R and D customer value proposition and the robust backlog position we have entering the year. And as we look longer term, The secular innovation trends in our end markets remain strong. Now let's take a deeper look at the strength of the 4th quarter. Record orders of $1,600,000,000 grew 9% on a core basis. Record revenue grew 15% on a core basis With solid growth across all regions as Keysight teams successfully navigated challenging dynamics.

Speaker 2

This resulted in record quarterly earnings of $2.14 per share. The strength and resiliency of our business model It's due to our strategic efforts to diversify our industry exposure. This has been best exemplified in the growth of our Electronic Industrial Solutions Group and our ability to leverage our industry leading first to market solutions To enable expansion across the broader communications ecosystem, EISG achieved its 9th consecutive quarter of double digit order and revenue growth. Auto, Semiconductor Solutions and General Electronics all achieved record quarterly revenue. For the year, both orders and revenues set new records as we capitalize on continued investments across all three In automotive, we're pleased with the continued adoption of our solutions portfolio as orders grew double digits The 7th consecutive quarter and exceeded $500,000,000 this year.

Speaker 2

Automotive OEMs and their suppliers Continue to focus on strategic new mobility investments, which drove key wins for Keysight. In addition, automotive focused semiconductor companies continue to add capabilities to support EV and AV applications, which we view as a favorable long term dynamic. We recently announced the Synlab DC Emulator, which enables customers to accurately characterize high voltage, high power electric vehicle battery performance under varying real world charging conditions. And Keysight's PathWave Labs operations software won 2022 Auto Tech Breakthrough Award for overall electric vehicle technology. In support of AV applications, Silicon designers are exploring adoption of commercial standards such as MIPI for automotive and other surround sensor applications, including cameras and in vehicle infotainment displays.

Speaker 2

We are now expanding our leading compliance test solutions to offer advanced verification and diagnostic capabilities for automotive designers. Turning to our Semiconductor Solutions business. Q4 was the 10th consecutive quarter of double digit order growth and a record revenue quarter. We saw sustained demand In addition, Keysight has continued to partner with industry leaders Synopsys and Ansys on RF and millimeter wave Integrated circuit design flows built for today's wireless communication requirements, including 5 gs and 6 gs system on chips. Keysight received a Partner of the Year award from TSMC for joint development design flows in RF and millimeter wave nodes.

Speaker 2

In General Electronics, record orders grew double digits this quarter as demand remained strong and broad based The business delivered strong orders and record revenue. Annual orders and revenue were all time highs Despite geopolitical headwinds and delays in U. S. Defense budget appropriations, commercial communications revenue grew 10% this quarter and 11% for the year, with growth across all regions. Investments across communications ecosystem continued throughout the year Growing deployments around the world and steady evolution from 400 gig to 800 gig to terabit Ethernet drove growth.

Speaker 2

We had another record year for 5 gs orders as Keysight's market leading solutions continue to provide the industry with new capabilities needed for development of next generation devices as well as wireless and wireline networks. Examples that highlight our portfolio's alignment With key industry priority include a recent partnership with IBM to integrate our Open RAN capabilities 5 gs location based service use case from Global Certification Forum by combining the testing of 5 gs new radio And global navigation satellite system technologies into a single platform. Lastly, in collaboration with key Silicon and Data Center Partners, we enable the industry's first 1.6 Terabit transmission and data center interconnect, Leveraging our high speed digital solutions. Aerospace, Defense and Government Business revenue Grew 4% for the quarter and 3% for the year, setting a new record while navigating geopolitical headwinds. Steady investments in spectrum operations, cybersecurity and space and satellite drove demand.

Speaker 2

5 gs continued to expand in aerospace and defense end markets, and we saw increasing investment in advanced research. Proposed increases in investment in the U. S. And Allied Countries for modernization of defense capabilities And new satellite and space applications position us well for future opportunities. As an integral part of our solution strategy, Software and Services order and revenue growth this year continued to outpace Keysight overall, which has driven our annual recurring revenue to approximately $1,200,000,000 Software and Services again represented just over 1 third of Keysight's total revenue for the year.

Speaker 2

Keysight's focus on customer success and innovation is driving our development of first to market, high value solutions. Our achievements over the years exemplify Keysight's collaborative culture and our talented workforce, And we are honored that Keysight has placed 10th on the Fortune's Best Workplaces in Technology list for 2022. We believe our differentiated culture gives us a unique ability to recruit and develop capable talent and will be our sustaining competitive advantage. In conclusion, I would like to thank our employees for all their contributions, commitment And strong track record of execution. In the midst of an uncertain economic environment, we remain confident in the resilience of our business, the strength of our balance sheet and the flexibility of our operating model.

Speaker 2

Now I'll turn it over to Neil to discuss our financial performance and outlook in more detail.

Speaker 3

Thank you, Satish, and hello, everyone. We Supply constraints continue to be effective. While the supply chain situation improved within the quarter, it continues to moderate our near term revenue expectations. Record orders of $1,570,100,000 increased 5% or 9% on a core basis, And we entered fiscal year 2023 with over $2,500,000,000 in backlog. Looking at our operational results for Q4, we reported gross margin of 64%, which as expected was down 80 basis points sequentially due to inflationary pressures And increased shipments of lower end instruments enabled by the improving supply chain.

Speaker 3

Operating expenses of $494,000,000 were well managed And we generated operating margin of 30%. Net income was a record $386,000,000 and we achieved 2.14 dollars in earnings per share, which was $0.14 above the high end of our guidance. Our weighted average share count for the quarter was 180,000,000 Foreign exchange impact on our earnings was negligible, thanks to a meaningful natural hedge provided by our global footprint, Which was then supplemented by our financial hedging program. Moving to the performance of our segments. The Communications Solutions Group achieved record revenue of $992,000,000 up 8% or 11% on a core basis.

Speaker 3

CSG delivered gross margin 66% and operating margin of 29%. Commercial Communications generated of $681,000,000 in the 4th quarter, up 10% driven by strength across the 5 gs ecosystem, increasing O RAN adoption An investment in 800 gigabit and 1.6 terabit R and D. Aerospace, Defense and Government achieved record revenue of 3 Industrial Solutions Group achieved record revenue of $451,000,000 up 20% or 25% on a core basis, driven by EISU reported gross margin of 60% and operating margin of 32%. Turning to our full year financial performance. Keysight delivered outstanding results in 2022 despite ongoing supply constraints, Foreign exchange headwinds and incremental trade restrictions.

Speaker 3

FY 'twenty two revenue totaled $5,400,000,000 up 10% year over year We're 12% on a core basis. Gross margin was flat at 65%, holding steady in the face of significant inflation. We invested Net income was $1,400,000,000 or $7.63 per share, up 22%. Moving to the balance sheet and cash flow. We ended our Q4 with more than $2,000,000,000 in cash and cash equivalents, generating cash flow from operations of $398,000,000 And free cash flow of $340,000,000 Total free cash flow for the year was $959,000,000 Representing 18% of revenue and 69% of non GAAP net income.

Speaker 3

Share repurchases this quarter totaled approximately 800 1,000 shares at an average price per share of $158.77 for a total consideration of $126,000,000 This brings our total share repurchases for the year to approximately 5,400,000 shares at an average share price of 156 And $0.09 for a total consideration of $849,000,000 or 89% of free cash flow. Now turning to our outlook and guidance. We exit the year with record backlog and confidence in Keysight's ability to continue As a result, we expect Q1 2023 revenue to be in the range of 1.3 $60,000,000 to $1,380,000,000 and Q1 earnings per share to be in the range of $1.81 to 1 0.87 Based on a weighted diluted share count of approximately 180,000,000 shares. A few modeling Reminders as we enter the year. Our annual compensation cycle is administered in Q1.

Speaker 3

And in this current inflationary environment, We expect our 2nd consecutive year of wage increases above our historic average. We are targeting FY 'twenty three R and D investment at approximately 16% of revenue, annual interest expense is expected to be approximately $80,000,000 capital expenditures are expected to be approximately 2 And we are modeling a 12% non GAAP effective tax rate for FY 2023. In closing, we recognize the uncertainty of the And we'll continue to be disciplined. Keysight's highly flexible cost structure, track record of execution, diverse end markets and Long term secular growth drivers give us confidence in our ability to outperform the market. With that, I will now turn it back to Jason for the Q and A.

Speaker 1

Thank you, Neil. That concludes our formal remarks. Dante, could you please give the instructions for the Q and A?

Operator

Of course, sir. We ask that you please limit yourself to one question and one follow-up. Our first question comes from the line of Samik Chatterjee. Your line is now open.

Speaker 4

Hi. This is Angela Jin on for Islamic Chatterjee. Congrats on the strong quarter and outlook. My first question is sort of related to what you mentioned briefly in the prepared remarks on sort of macro slowdown and Perhaps some pullbacks. I'd like to dig in a little more there.

Speaker 4

Given that we've seen commentary from other companies indicating that there is a pullback in telco CapEx, Are you seeing any impact to their R and D budget? And then I have a follow-up. Thank you.

Speaker 2

Thank you, Angela. Yes, we're very pleased with the quarter. And in consideration of this environment, pretty strong results And also a strong finish to the year. And as I stated, we saw a steady level of spend from a demand perspective through the quarter. All our regions from a sales perspective grew, so it was broad based.

Speaker 2

And going into a little bit on the end market color, I would say 5 gs Continues to remain strong. We grew our 5 gs orders double digit strength in R and D and also with the inflections So we're seeing in deployments around some parts of the world, even some of the manufacturing spend there remained strong for us this quarter. And we did see pockets of weakness in the broad component ecosystem, and that was An area we obviously watch carefully and that is related to the smartphone demand. And if you look at the cloud and data center markets In wireline, while some of the cloud direct cloud spend from the cloud providers was pushed out service providers was pushed out, the broad spend To adopt 400 gig and 800 gig continues to remain strong. So the focus on R and D and new innovations remain strong.

Speaker 2

Moving on to Aerospace and Defense Business, obviously, it was still a strong quarter for us, but we did not see the typical Year end surge that we would expect given the budget appropriations process. And then moving to EISG end markets, All of the markets remain strong, right? Automotive, we had strong double digit growth as continued investments and inflection from EV and AV are playing out. Semiconductor is an area we watch carefully, but because of our exposure into the wafer stage equipment process and new node, Specifically, Newnodes, that remains strong. And lastly, the General Electronics business, which typically It's part of its spend from PMI continued to remain strong from a demand perspective.

Speaker 2

So I would say we're doing well, and The customer activity with our customers and engagements remain strong and quite pleased with our quarter in this environment.

Speaker 4

Great. Thank you so much for that color. And then just for my follow-up, you posted 10% revenue growth this year. And I know your long term guide is sort of mid single digits revenue growth. Just what are you thinking sort of broad strokes 23 or do you still expect to sort of perhaps trend above your typical long term range?

Speaker 2

Thank you. Yes. We remain confident, Angela, with what we see so far. Obviously, it's an uncertain environment, so we're guiding 1 quarter at a time. You see the conference reflected in our Q1 guide, which is which we feel good about.

Speaker 2

And as we look forward, We'll look at the demand environment, and we'll keep you updated as we go.

Operator

Thank you for your question, ma'am. Our next question comes from the line of Chris Snyder with UBS. Your line is now open.

Speaker 5

Thank you. I just kind of want to follow-up on those comments on the market demand commentary. I mean, orders were, I think you said, steady each month of the quarter and up 9% year on year. So what should we make of the commentary that maybe customers are being a bit more cautious? Because Satish, as you just kind of ran through all the different Sub segments and businesses, it seems like everything is going quite strong.

Speaker 5

If we take this as maybe an indicator that fiscal Q1 orders Are easing a bit? And ultimately, does this push that the growth profile back to that 4% to 6% normalized range? Or could it Thank you.

Speaker 6

Hi, Chris. This is Mark. I'll take that and add a little bit more detail here. As Satish said, our order level was steady throughout the quarter. So we're watching this, right?

Speaker 6

Because if customers are taking more time to make decisions, You would look for orders to slow down. They did not. As a matter of fact, October was very strong. It was a record October for us in terms of orders. So that's good.

Speaker 6

You've heard us talk about before the addition of new customers. We've added about 450 this quarter again for nearly 2,000 new customers across the whole year. So that creates more diversity and durability to our business, and I see that paying off. Our top 20 customers in the quarter were up Strong double digits as well. So all of that continues to translate to the fact that we did not see an impact to our business because of The customer is taking more time.

Speaker 6

And I think it also has to do with the fact that we are so biased toward R and D and design optimization. And as we've seen through other waves in the recent term where some markets slowed, the advanced technology Development continues. So that's what we see, but we look around and we do see some macro uncertainty. And from my What I see in terms of order or in terms of customer activities is very active customers. Our 6 month funnel continues to grow, But customers are taking more time to make ultimate CapEx decisions.

Speaker 3

Yes. And this is Neil. I'd just Give you a little bit maybe more quantification of the situation going into Q1. So while we don't guide orders, I would point out that we have A bit of a difficult compare here in the Q1. A year ago in Q1, that was the first time in Keysight's history that we'd ever posted order Moving from the end of Q4 into the Q1 of the new fiscal year.

Speaker 3

So we've got a tough compare from that perspective. In addition, as you all know, The U. S. Dollar began to strengthen pretty significantly in the back half of this year. We estimate the FX headwind in our first Quarter to be a full 5 percentage points, and so we've got a 5 point FX headwind, and we estimate another 2 to 3 points of headwind from The recent increase in China trade restrictions as well as the loss of our Russia business, which happened in the Q2 of last year.

Speaker 3

So Those things combined give us a 7 to 8 point headwind, just coming out of the gate here as we enter the Q1.

Speaker 5

I appreciate that. And On the commentary that customers are taking longer to order, maybe they're ordering slower, How do you separate kind of the supply chain element of that from the demand element? Because if supply chains are generally moving in the right direction, I think that you maybe customers will not kind of order with the same lead times or urgency that we saw last year. Thank you.

Speaker 2

Yes, Chris. I think you're right. I think as the supply chain continues to ease and The delivery duration that it takes for us to fulfill an order continues to pull in. You would expect some level of normalization as well. And The reason we also put out that the demand environment is moderating is we're starting to also see some of our customers whose earnings whose earnings has fallen, also put additional scrutiny on spend, right?

Speaker 2

And so that takes a little bit more time to close the deal as they go through their process. So those are some factors. Neil, I don't know if you want to I know you've commented on the normalization before.

Speaker 3

Yes. I guess the only other point that we make around that level is, if you look at our last 3 years, we've averaged a book to bill over the last 3 years of 1.09 driven first by COVID, obviously, then by the supply chain disruption that's happened over the last, say, 18 months. And so we've known for some time that, that book to bill had to normalize. And as our lead times come in, we would expect that normalization to Sure. And so as I think about it, and again, we're not guiding orders, but a move of our book to bill back to a more normal level, Something approaching 1 is not something that's going to impact our ability to continue to grow revenue.

Speaker 5

I appreciate all that color. Great quarter guys. Thank you.

Speaker 2

Thank you, Chris.

Operator

Thank you for your questions, sir. Our next line of questions comes from the line of 1 of Mehdi Hosseini with SIG. Your line is now open.

Speaker 7

Yes. Thanks for taking my question. I have 2 follow ups. Let me go back to CapEx, the 250, Should I assume the capital intensity will remain around 3% in fiscal year 2023?

Speaker 3

Yes. So I mean one of the things that's happening with our CapEx is our capital purchases in this fiscal year were definitely impacted By the broader supply chain environment. And so we guided at the beginning of the year, I'm talking about fiscal 'twenty two now, To CapEx, that was close to $250,000,000 and we significantly underspent that from a cash flow perspective. But what you can't see is that our commits We're very much in line with our original expectations. It just took longer for things to be delivered.

Speaker 3

And so what we're seeing as we go into next year is a pretty dramatic Scaling back of new capital purchases, but with a little bit of a cash flow overhang as we go into And so that's what's going to carry our capital purchases up to that $250,000,000 level in fiscal 2023.

Speaker 7

So I shouldn't use your CapEx guide to come up with some revenue guide or revenue growth Expectation for fiscal 2023. There is some cash flow aspect of the CapEx, right?

Speaker 3

That's right.

Speaker 7

Okay. And then, let me go back to China. The APAC region as a percentage of revenue Has remained in the low 40% over the past several years, including the headwind from Huawei, should I assume that you are growing outside of China so much to the extent that you are Able to offset increased restriction on shipment to China? Is it just a mix within the APAC region That makes China kind of neutralize?

Speaker 2

Yes. I think maybe as we have spoken before, We have a broad based business in China. And despite the ongoing geopolitical situation, We have a demonstrated ability to pivot and address customers in that region. And given the focus there On technology development, I think we're seeing good demand in the region. But we're also seeing multinational companies There are creating there are moving out of China in some ways and into rest of Asia Pac and other parts of the world, including on shoring moves into North America, and we're successfully capturing some of that spend as well.

Speaker 7

Okay. So the fact that the supply chain is moving out to the China, that's positive. Now if I may just quick follow-up. So you do have more than 50% exposure to your customers' R and D budget. On top of that, There is structural changes happening with the supply chain that is also positive.

Speaker 7

And those two factors On aggregate, could offset some of the cyclicality nature or production related Sensitivity or volatility, is that the right way to think about this?

Speaker 2

I think that's what's playing out right now for us, yes.

Speaker 7

Okay. Thank you.

Speaker 2

Thank you.

Operator

Thank you for your questions, sir. Our next line of questions comes from the line of 1 Matthew Niknam with Deutsche Bank. Your line is now open.

Speaker 8

Hey, guys. Thank you for taking the questions. 2, if I could. First, on backlog. So you mentioned you ended the year at about $2,550,000,000 I think our math would suggest something about $100,000,000 higher Just relative to the 2.5 you mentioned last quarter, I'm just wondering if there's any order cancellations to be aware of or if there's an FX component affecting this.

Speaker 8

And then secondly, on the China trade restrictions, I think you've called out a 2 to 3 percentage point headwind from those restrictions. I'm just wondering, is that incremental In fiscal 1Q and is this primarily an EISG or could it show up elsewhere? Thanks.

Speaker 3

Yes. So this is me. I'll take the backlog question and then let Mark address the China question. But yes, so you're I mean, obviously, our orders within the quarter outpaced revenue by A little bit more than $100,000,000 So we do continue to add to the backlog as we've gone throughout the year.

Speaker 6

Yes. And Matt, the specific China trade situation that went into effect on October 7, so there wasn't much effect In our Q4, we will see some effect in our Q1, but the 1% to 2% is projecting out over a run rate of the check business for the entire year based on other situations. The other thing just to note is that we have not seen Any changes in our cancellations, it's been running at a historically low level for the last four quarters, and that was the case again in Q4.

Operator

Thank you for your questions, sir. Our next line of questions comes from the line of one Aaron Rakers with Wells Fargo. Your line is now open.

Speaker 9

Yes. Thanks for taking the question, and congrats on the good execution in the quarter. I just want to at a high level go back to kind of the defensibility of the model if I can. Can you remind us where the mix of the business stands Today between R and D exposed versus, let's say, manufacturing exposed. And I guess on that same kind of thought process is that Where do you stand as far as the monetization effect of the software strategy?

Speaker 9

Where do we think that progresses To over the next year, whatever time frame you want to think about.

Speaker 2

Yes. Thank you for the question. I think at So that's the sort of mix of the business. Clearly, we believe R and D is secular. You look at some of the areas in R and D that we're focused on That involved next generation innovations, such as with 5 gs and then 6 gs in automotive, and digital health, so on and so forth.

Speaker 2

And it really gives us This diversity of applications that gives us resilience in this environment for sure. With regard to the software strategy, it's again goes congruent with our go to market approach Because we're here to enable innovations to happen faster, and the way we do that is by offering more software centric solutions. So as we deploy more solutions to our customers, Increasingly, that is in the form of growing software mix and that goes again synergistic with our services strategy. So you look at our software and services revenue this year, we'll end at 34% of the total mix and Our ARR or annual recurring revenue has reached a new high of $1,200,000,000 and we'll continue to invest to grow those portions of the business and increase our resilience and durability over time as well. Thank you.

Speaker 9

Yes, thanks. And then as a quick follow-up if I can. Just curious when we think about the progression Backlog and we appreciate that your backlog is only looking out on a forward 6 month basis. Neil, just curious, how should we think about what a normalized backlog level looks like?

Speaker 3

Yes. I mean, given some of the dynamics that Satish just talked about, increasing software services, recurring revenue, we have seen growth In our deferred revenue over the same 3 year period of time as well as our migration towards systems rather than tools, I think we'll drive our ultimate backlog level when things normalize to be Significantly higher than it was, say, pre COVID in the 2018, 2019 timeframe. And so I think we'll have to see how that plays out over time. I think, Again, we built you can do the math. We built well north of $1,000,000,000 of backlog over the course of the last 3 years as we've had this book to bill that I've mentioned of 1.09.

Speaker 3

And as our lead times come in, we're going to expect Ordering patterns to adjust and lead times to pull in. I've said previously that there's probably 4 to 5 weeks Worth of kind of abnormal backlog as a result of 4 to 5 week extension of lead times kind of on average would be a way to think about it.

Speaker 2

But it's also important to add that we're still in a supply challenged environment. While it's improving, Supply is the constraining factor right now.

Speaker 5

Thank you.

Operator

Thank you for your questions, sir. Our next line of questions comes from the line of 1 Jim Suva with Citi. Your line is now open.

Speaker 10

Thank you so much. It's very noteworthy and impressive about your software and services, which I think is about 34%. Is it Can you help us understand like reasonable growth as a percent of totality going forward? Because I would imagine it's Very hard to ever get over 50% or are you looking at a point where it starts to level off around 35% or is that way too low? 40%, where could this kind of feasibility go for software and services as you kind of look at Adding these incremental benefits to your sales process.

Speaker 2

Yes, Jim, I think as a strategy, as a company from In 2015, we've been focused on the software centric solution strategy and really focused on our customers' most demanding and challenging The per incident sale, but our focus on this life cycle value creation for our customers, but also value capture for Keysight. And that's the journey we've been on. Some of the more newer solutions such as in Open RAN that we've talked about where we are seeing considerable traction, Software alone is nearing 40%, 50% of the total sale value and with a lot Bigger portion of it being in the recurring category as well. So we feel good about the continued traction we're seeing for our solutions. And as we continue to deploy the solution strategy over time, we will enter into new end market verticals.

Speaker 2

And as you've seen some examples I put out This latest earnings announcement, we've also had some successes in the automotive sector with deploying software and in the

Speaker 6

You mentioned that, and that is an important element of this. We are attaching upfront attached services and software. We're at about 60% for services today. I want See that growth, so that's another stream of advancement. The other thing that you can see is, we are delivering solutions more and more through updates To our software, if you think about our 5 gs solutions going from release 15 to release 16 and 17, much of that is software updates that Creates additional opportunities for upsell, cross sell and, of course, recurring revenue as well.

Speaker 6

So there's and there's several elements of our go to market that we are deploying now to encourage that recurring growth and expansion of attachment upfront to our total solutions.

Speaker 10

Great. And then my follow-up is on the China. I think I heard 2 to 3 points of headwinds. Is that for kind of the full Fiscal year, was there any like in calendar I'm sorry, fiscal Q4, like buying ahead of the rule changes? I'm just trying to kind of Triangulate around the magnitude of it, and I assume after fiscal 'twenty three, it's kind of all out of the model from the rule changes?

Speaker 6

Yes, Jim. I think we said 1 to 2 points of headwind for the entire fiscal year 'twenty 3. And again, that's based on what we estimate as the run rate of business that won't be available to us with the new trade restrictions. There will be a little bit more in Q1 as we look at some of the backlog, but that's the run rate. And then there was another I think Neil mentioned another point of headwind with from Russia.

Speaker 10

Great. Thank you so much and congratulations to you and your teams.

Speaker 2

Thank you, Jim.

Operator

Thank you for your questions, sir. Our next line of questions comes from the line of Juan Mata Marshall with Morgan Stanley. Your line is now open.

Speaker 11

Great. Thanks. In the past, you guys have talked about kind of The 5 gs peak was going to be much lower than kind of investors were expecting, but you kind of talked about a 2023, 2024 time period for the 5 gs peak. I just wanted to kind of get current thoughts on that and just how initiatives like O RAN or Just some of the other initiatives are maybe extending that. And then maybe second, you gave some context that you're seeing some Loosening and supply chain, but just kind of what is current thinking?

Speaker 11

Is it still just a small amount of parts So you're kind of waiting to release, but just when do you see more general availability of those parts and just kind of a tightening between supply and demand? Thanks.

Speaker 2

Yes. Thank you, Matt. I think on the 5 gs front, I think as we have always stated, there are multiple catalysts. I think about 18 months ago, I said the first catalyst was the C band deployments in the U. S.

Speaker 2

That's played out as we had hoped and we have captured A lot of that's spent. We are pleased with some action that's happening in Asia and India, parts of India that have made commitments to roll out 5 gs. So that's again opportunity for us that's playing out right now. But the second and the third parts to this is the millimeter wave Opportunity, there's still some complex challenges with millimeter wave that customers are trying to solve. That continues to be a longer term R and D opportunity for us as that deployment has continued to push out, any way scale deployments anyway.

Speaker 2

And lastly, As 5 gs is deployed, operators are looking to further monetize by adding the SA versions and new Applications such as Open RAN continue to be gain traction across the global ecosystem. And so the opportunity that we have in R and D continues to grow, and we're well positioned with the comprehensive offerings we have to address it. I also want to point out that we have a very diversified business. Yes, 5 gs gets a lot of attention, but we have secular Trends in wireline evolutions, which we are well positioned to capitalize on based on the acquisitions of Ixia that we have made, and we continue to see tractions there. Not to mention the newer additions to our go to market with automotive and with next generation semiconductor nodes.

Speaker 2

So We run a diversified business, and I think that's source of greater stability for us and over time. The second part of the supply chain question that you asked is, at the beginning of last year, We took a series of actions to basically redesign our products to second source components, and we had a We've talked about it on earnings calls, and all those actions have really enabled us to do better than we expected every quarter. But as we think about the supply chain, I speak with a number of our semiconductor supply chain partners, and They're all putting actions in place to obviously increase capacity, but it still continues to be a constrained environment. We're not back to this pre COVID Sort of supply environment yet, it might take all of 23 to get there from our best information right now.

Speaker 11

Great. Thank you.

Operator

Thank you for your questions, ma'am. Our next line of questions comes from the line of 1 David Ridley Lane with Bank of America. Your line is now open.

Speaker 12

Sure. Good evening. You talked about some of the headwinds to revenue in the Q1, but one tailwind not mentioned is pricing. And just wondering how significant is pricing today versus more normal levels? I mean, are you getting a couple of points Tailwind from that?

Speaker 12

And then what type of volume growth is really embedded into Q1's guidance?

Speaker 3

What was the last part of the question? I'm sorry, David, I missed just that last part.

Speaker 12

Sorry, the type of volume growth is embedded in the Q1 guidance.

Speaker 7

Yes.

Speaker 3

I mean, I think the pricing question, obviously, we've had we've been doing our best to keep place with inflation. We've had multiple rounds of price Increases over the course of the last 12 to 18 months, and those are embedded in the backlog. Although I think you can see, Based on the fact that we have maintained margins over the course of fiscal 2022, it's flat at 65 Which frankly, I think in this inflationary environment was a very strong result that we're basically keeping pace on a margin basis With what we're seeing in terms of increases. And so right now, while on the one side, yes, we have these Price increases that are embedded in our backlog and will continue to yield dividends and revenue, it's not like the inflationary elements have stopped in the cost structure as well. I referenced, for example, that we are going to be doing our salary administration for next year here in our fiscal Q1, And this will be our 2nd consecutive year with salary increases that are materially above Our historic averages.

Speaker 3

As to the volume question, given the nature of our business where we're selling instruments Literally cost, in some cases, 100 of dollars and in other cases, cost $1,000,000 That's a very difficult question to answer. There's such a high deviation of mix That it's really hard to get to a meaningful answer on that question.

Speaker 12

Sure. And as a follow-up, another tailwind here is autos, right? I think last quarter you mentioned that It's basically doubled over the last 2 years. This quarter, you mentioned $500,000,000 in orders. So it's nearing Close to 10% of your orders in this fiscal year.

Speaker 12

Do you feel like the trend there It's kind of, I don't want to say, not subject to sort of

Speaker 6

David, this is Mark. I'll answer that. The growth we're seeing is coming from next generation mobility. There's some continuing R and D on the electronics side that's It's more conventional, but the growth in new mobility is sustaining, it is secular, and it doesn't just Stop at the vehicle. It goes out into the charging infrastructure, into the underlying battery technologies.

Speaker 6

And we've seen what's happened here in the last With different countries and different regulations pushing this further toward adoption, The adoption in Europe is very strong and growing fast in other regions as well. And our position in the market is Very strong helping our customers design and deploy this next generation technology The batteries to the charging infrastructure and then add on top of that all the connectivity and communications and protocols as we talked about in the prepared statement. So This is really a great intersection of multiple strengths for us and it has long term secular growth drivers behind them.

Speaker 12

Thank you very

Operator

much. Thank you for your questions, sir. Our next line of questions comes from the line of 1 Rob Mason with Baird. Your line is now open.

Speaker 13

Yes. Good evening. Thank you. Neil, I wanted to just clarify, you mentioned that R and D, I thought it would be roughly 16% of revenue this year. I just want to make sure that's correct because that's about a point more than it was This past year in 2022, and just I'm curious how that steps up and what does an exit rate look like If that's the case?

Speaker 3

Yes. So you're right. Obviously, our 16% or 16% plus has been our long term target. We under Spent that here in FY 'twenty two. I think a big function of that was the revenue outperformance within the year.

Speaker 3

If you remember, this time last year, we guided you 6% revenue growth on the year, and we actually grew 12% on a core basis. And so our R and D plans for the year were much More aligned with that lower level of revenue growth. So I think as we go, we certainly continue to see a large Amount of opportunity for us to continue to invest in the future growth of our business, a lot of pull from our customers to do R and D work. And so our intent is to revamp back towards 16% of revenue. Obviously, the salary administration here in the Q1 is going to help to move us In that direction, we may not get to 16% here in the Q1, but looking at an exit rate that's at 16% or even A little bit above by the time you get out to the Q4 is not out of the question.

Speaker 3

Okay.

Speaker 13

Okay, that's helpful. And then To the extent that supply chain does still remain somewhat tight through the year, how are you thinking about working capital? And Any ability to pull that down as you go through the year? What are you thinking about working capital contribution for the year.

Speaker 3

Well, I certainly think over the longer term that as the supply chain normalizes, there will be an opportunity for us to for us to reduce some of the working capital that's built up over the course of the last year. We see it in terms of inventory, increased inventory Via the prices that we're paying for 4 parts, we see it money tied up in terms of Commitments to buy future inventory where we paid in advance for future delivery has been a use of working capital that frankly is new over the course of the last 12 months. And then frankly, the supply chain situation has significantly impacted the linearity of our revenue within the quarter. You can imagine when you move from more of a just in time environment where you're just building and shipping and building and shipping, we're doing a lot more You know, build to a certain stage, wait for parts, finish and ship. And so our revenue has tended to be more back end loaded, which Results in us carrying more receivables at the end of the quarter than we would if we were shipping in a more linear fashion.

Speaker 3

So again, I think it's a function of how does Supply chain normalized and when does that eventually happen? That is you need a little bit of a crystal ball to answer that question. But when it does happen, we would see we would expect to see an ability to reduce working capital.

Operator

Very good. Thank you. Thank you for your questions, sir. That concludes our question and answer session for today. Would like to turn the conference back to Jason Kary for any closing remarks.

Speaker 1

Thank you, Dante, and thank you everyone for joining As he mentioned, that concludes the call, and we wish you all a good evening and look forward to seeing you soon.

Operator

This concludes our conference call. You may now disconnect.

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Earnings Conference Call
Keysight Technologies Q4 2022
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