The Keysight Technologies Fiscal Third Quarter 2023 Earnings Conference Call began with Cole, the lead operator, introducing Jason Kary, the Vice President, Treasurer and Investor Relations. Kary welcomed everyone to the call and explained the supplementary financial information available on their website. He also discussed the use of non-GAAP financial measures and core growth, and warned of forward-looking statements and risk factors. Kary then turned the call over to Keysight's President and CEO, Satish Dhanasekaran, and their CFO, Neil Dougherty, who would be joined by Chief Customer Officer, Mark Wallace, during the Q&A session.

Keysight reported strong financial performance in the third quarter, with revenue in-line with expectations and record earnings per share exceeding guidance range. Orders were at the low end of expectations, but R&D spending and stability in commercial communications was seen. The near-term outlook has been tempered, but the company's diversified business, differentiated solutions, and durable operating model give them confidence in their ability to capitalize on long-term growth trends. Gross margin was 66%, and operating margin was 31%, resulting in an all-time high of $2.19 in earnings per share.

The Electronic Industrial Solutions Group saw double-digit growth across all markets and regions in the third quarter, with customer engagements remaining high. Despite a near-term pullback in capital spending for wafer capacity in semiconductor, the industry is still planning for a strong future demand environment, with customers prioritizing new applications such as silicon photonics to address the AI demand. In automotive, investments in EV and AV technologies continued to be strong.

Keysight secured a third strategic win with a large European OEM to supply an EV battery test system that includes their PathWave Lab automation software. They also announced support for automated RF testing for Autotalks' C-V2X chipsets and are expanding customer engagement in digital health solutions. In Communications Solutions Group, revenue declined 5%, while Aerospace, defense, and government revenue grew 11%. Commercial Communications revenue declined 12%. Keysight's differentiated signal generation and threat scenario emulation capabilities led to a large U.S. Air Force contract. They are also seeing strong demand for their radar and defense modernization solutions, as well as government research demand and investment in 5G and 6G. Customer engagements remain strong with R&D investments in key technology to support 5G and 6G AI/ML-driven high-speed datacenter networking and satellite communications.

Keysight saw increased demand for their wireline applications driven by cloud provider and hyperscaler investments, and steady investment from enterprise customers and key service providers due to digitization, heavier network loads, and cyber security concerns. They are continuing to strengthen their technology leadership in the industry, introducing new platforms and capabilities for power amplifier and component design, and enabling 3GPP protocol conformance validation for Release 17 non-terrestrial networks. Software and services revenue grew year-over-year, accounting for one third of total company revenue.

Keysight delivered solid financial performance in Q3, with revenue of $1.382 billion and orders of $1.244 billion. The company announced its intent to acquire ESI Group, a leader in virtual prototyping solutions, in order to broaden its software capabilities into physical simulation. Despite macro uncertainty, Keysight is continuing to invest in long-term secular growth trends and is also driving cost efficiencies. The company expects 7% EPS growth and 1% revenue growth for the fiscal year 2023.

Ciena reported gross margin of 66% and operating expenses of $478 million, resulting in a record operating margin of 31%. Revenue from the Communications Solutions Group was down 5% while revenue from the Electronic Industrial Solutions Group was up 14%. The company ended the quarter with $2.6 billion in cash and cash equivalents and generated cash-flow from operations of $241 million and free cash flow of $196 million. The demand environment was mixed with areas of stability and growth partially offsetting pockets of incremental softening.

Satish Dhanasekaran was asked about the trends in EISG orders, given the weak smartphone ecosystem. He explained that demand trends were stable, and that there was an uplift in demand from AI applications on the wireline side.

Satish Dhanasekaran explains that Keysight's team executed well, resulting in 7% EPS growth and 1% revenue growth for the year. Despite a 10% year-over-year decline in orders in Q2, the Americas business grew on top of a record Q3 a year ago and Europe was stable. The Aerospace and Defense segment grew, while the EISG segment declined. 5G investments in R&D remained stable, however there has yet to be an uptick in manufacturing business associated with components due to declines in smartphone volumes.

Keysight is seeing an increase in R&D investments and investments in 800 gig due to the premiumization of the smartphone market and AI. The Network and Security business is also doing well and taking share. To get back to their long-term growth outlook, Keysight needs to see an increase in orders going into next year.

Satish Dhanasekaran explains that the success of the company is due to its execution and breadth of end markets served, such as aerospace, defense and automotive. Neil Dougherty adds that the demand environment has decreased and put pressure on orders, leading to a decrease in the ability to drive revenue based on backlog. They have burnt through $300 million of backlog this year.

The company has seen an increase in orders for longer-term strategic projects, with 8% of orders in the past three quarters coming from this area. This has added an additional $200 million of backlog to the $300 million burnt through the year. These projects are high-quality and involve comprehensive solutions such as power management and software for workflow automation. These new applications are expected to provide long-term growth for the company.

Neil Dougherty and Satish Dhanasekaran answered Mehdi Hosseini's question about backlog normalization. Neil Dougherty said that they had worked through the abnormal backlog of $400-500 million and converted it into long-dated programs. Satish Dhanasekaran added that software and services continue to be strong, which leads to a two-zip code calculation. Mehdi Hosseini then asked a follow-up question about the semi-mix.

Satish Dhanasekaran and Mark Wallace discussed the impact of the delayed ramp of tape-outs for 3 nanometers on the semi-related orders, noting that there has been a pullback in the near term but that it is temporary and transient. They also highlighted that customers are still engaging with the company on advanced process technologies, including 3-nanometer, 4-nanometer, and 2-nanometer, and are looking at a variety of aspects of their market and managing their finances.

Neil Dougherty believes that backlog has normalized and that incoming order rates are typically higher in the fourth quarter due to seasonality. He expects this to positively impact their business in 2024.

Neil Dougherty and Satish Dhanasekaran discussed the expected increase in orders from Q3 to Q4, and Aaron Rakers asked about the ESI acquisition. The acquisition is a great strategic fit, accretive to gross margins and SOFR percentage, and culturally important as ESI has been around for 50 years and involved in complex simulations.

Satish Dhanasekaran and Mark Wallace discussed the shift to longer-term orders in the aerospace, defense, and auto OEMs industries, which is driven by both the implementation of Keysight's solutions approach and the increased demand in the automotive sector. They gave examples of the strategic and complex engagements with customers that they have seen.

In the fourth quarter, Neil Dougherty expects a slight decline in gross margin due to a reduction in volume. This is partially due to the fact that people tend to spend less money during the summer holiday. Satish Dhanasekaran then discussed the complexity of setting up an EV or battery test lab, which includes multiple racks of equipment, low voltage interfaces, chillers, environmental chambers, safety aspects, fixturing software, project management, installation, and site prepping. This allows them to gain deeper visibility into the customer's business and uncover new opportunities.

Neil Dougherty discussed the outlook for FY 2024, noting that there will be difficult revenue comps as they enter the year due to the higher than seasonal order rate in the first three quarters of FY 2023. He expects the typical seasonal decline in revenue from Q4 to Q1, and does not currently see a catalyst that would drive a significant market recovery in the first half of the year.

Satish Dhanasekaran and Matt have both said that the company will be looking to a recovery in the second half of the year, as many of the issues impacting the markets are temporary. They are confident in the long-term outlook and will be making investments to be ready for the recovery while still relying on their discipline to drive EPS growth. Satish has also mentioned that they have been staying disciplined and have executed well on their synergy work, keeping their OpEx flat despite the inflation environment.

Chris Snyder asked about the sharp decline in margins from Q3 to Q4, to which Neil Dougherty responded that it may not be as steep as initially thought. He attributed the decrease in gross margins to the drop in volume, as well as some one-time favorable impacts in Q3 that won't be repeated. Snyder then asked about the cash tax rate for 2024 versus 2023, to which Dougherty did not respond.

Neil Dougherty and Satish Dhanasekaran discussed the revenue guidance for Q4, which is expected to be down 10% for both segments. They noted that defense budgets are increasing globally, which bodes well for their aerospace and defense business. They expect Q4 to be seasonally strong due to end-of-year budgets coming open.

Satish Dhanasekaran spoke about how R&D investments are being preserved to outperform the market, as well as how AI projects are being launched in silicon and networking. He also discussed how the move to 800-gig ethernet is playing to their strength and is helping them pick up orders. Finally, he explained that deployments are continuing to scale, globally, as well as the standards progression of Release 17 new use cases which are driving customer need.

Satish Dhanasekaran discussed the potential of 800-gig ethernet for AI applications and how the company's ability to be first-to-market in this area is helping them to win early engagements. Neil Dougherty then discussed the EPS contribution that the ESI acquisition is expected to make when it is integrated.

Satish Dhanasekaran and Neil Dougherty discussed the complexities of closing a public deal in France and the ability to leverage their G&A and sales force to drive significant margin expansion and EPS growth. They also clarified that there had been no change to their order acceptance policy, but that longer-dated orders that are complex systems require a start work today by inventory and staff and are generally uncancelable without significant penalty.

ESI Group has the ability to simulate complex physical and electrical interactions, giving them a unique position in the market. This, combined with their software-centric transformation and French base, gives them the opportunity to focus their go-to-market motion and accelerate growth. They are also able to deliver projects up to 12 months in advance, with some projects scheduled for revenue recognition in 2025.

In response to a question about orders, Satish Dhanasekaran reported that the Americas business had grown year-over-year in Q3 and Europe was stable. Mark Wallace then elaborated on the growth of orders, noting that it was a combination of first-time wins with automotive OEMs and up-selling and cross-selling capabilities to existing customers. He then described these longer-term programs as being as strategic as possible with customers.

Jason Kary and Satish Dhanasekaran concluded the call with a few key takeaways: they are executing well and are on track to deliver 7% EPS growth and 1% revenue growth this year, they have a strong differentiated portfolio that is aligned with multiple end markets and customer priorities, they have a strong balance sheet and cash position, and they have a proven operating model with a highly flexible cost structure.

Satish concluded the conference call by reminding everyone that the company is confident and excited about the long-term trends that will support their growth strategy. He also mentioned that the management team has decades of experience and will remain proactive and balanced in navigating the current environment. Lastly, he expressed his hope that the company will emerge from the current environment stronger.

This summary was generated with AI and may contain some inaccuracies.