Keysight Technologies, Inc. (KEYS) Earnings Call Transcript & Summary

All right. Great. Thank you, everybody, for joining for our next session. For those of you who don't know me, I am Matt Niknam, the communications analyst here at Deutsche Bank. We're really pleased to be joined by Keysight's CEO, Satish Dhanasekaran; as well as SVP and CFO, Neil Dougherty. Welcome, both. It's great to have you guys. So this is going to be sort of a fireside chat format. If anybody has any questions, feel free to raise your hand. We've got people with mics around the room.

So maybe just to start, high-level question maybe for Satish and Neil, feel free to chime in as well. What would you say are the top priorities you're focused on as you close out fiscal '22 and head into fiscal '23?

Yes, I think -- thanks, Matt. First, I would say is, we've had a great track record of execution in the company and the strength and the resilience is proving itself out, whether it's the supply chain or COVID. Or even before that, the fires in Santa Rosa, which we've had to overcome. So I think that execution capability we preserve for the long run, and we take our commitment seriously. So that's the first important thing, I think, in this environment. The second is continuing our transformation and growth track record. We've been able to outgrow our markets and that's how we think about it. We know the economies do have a lot of pressure, and we know that that's going to be something we're all thinking about in 2023, but our job is to continue to create value for our shareholders and outperform our markets. And that's what we remain focused on. And to that end, continuing our first-to-market strategy around the secular themes like 5G, automotive, semiconductor and other areas where we continue to see multiyear roadmaps where our customers remain committed to executing to them and that's a critical part of it. We have a very strong backlog position and exiting the last quarter, and we expect that, that will be the case as we exit this year, which means our customer demand remains strong. And I think that will allow us to continue this value creation pipeline. And then when you look longer term, we're looking at the rate of technology only going to accelerate, whether it is in areas like energy and sustainability or with longer term into metaverse and other technology trends. And it really offers us a very rich arena to implement our strategy of software-centric -- providing software-centric solutions and that will continue to grow the value of the firm.

Got it. Got it. So it's been about 4 months, I think, since you took over as CEO. Belated congratulations, by the way.

Thank you.

What would you say have been the biggest surprises or key learnings for you thus far, whether positive or negative? I don't need to put you on the spot.

Yes. No, thank you. No, I would say that I've been in the firm for 15-plus years, and I'm one of the less tenure employees because most people have been here longer than that at Keysight and because they enjoy it. The culture is very strong. The innovation environment that we serve remains very strong as well. And I think -- I was previously the Chief Operating Officer of the company. So they're -- so I'm familiar with the breadth and the scale. But I think, as a CEO, just looking at the end markets we serve, the thing that strikes me most is the uniqueness of the value that Keysight creates in its marketplace. I mean you look at a $20 billion market, and you think of it having many players. We only have 25% share. So a lot of upside there. But the unique value that we bring to our customers is something that I've heard from a lot of our customer executives, the critical role we play in their programs to enable their time to market. There's another message that I've heard from customers as well, and I think being in the company for 15 years, I think hearing it as a CEO, it brings a different level of context to it, but also equally excited by the opportunities we have as we look forward. So it's probably 3 things. Not surprised by the strength of the resolution, the execution progress of the company, and we will continue to preserve that as we move forward.

Got it. Got it. You talked a little bit about the strength of the backlog. Obviously, we've seen order growth reaccelerate in the past quarter despite tougher comps. So I'm wondering if you could just talk a little bit about how demand has been trending, particularly amidst maybe a little bit of tougher macro backdrop.

Yes. I would say, the secular growth themes, again, I go back to the areas where across our end markets that we've been focused on, whether it is in the wireless or wireline technologies with 5G being a driver there or 400-gig, 800-gig capabilities. We have a differentiated position and that continues to drive demand. Automotive, despite the auto industry being somewhat hampered from scale because of the shortage of chips, but the demand is very, very strong. It's 6th consecutive quarter I mentioned our strong double-digit growth in the pipeline for EV and AV offerings remains robust, and aerospace defense with the geopolitical situation being what it is. So we have 3 end market exposures diversified and -- so we see strength. And what was maybe surprising for me in this quarter was our European -- strength in our European operations because many people think Europe may already be in a recession, and we had a stronger performance than anticipated in Europe.

All right. Any color you can share in terms of what you've seen with order trends thus far in fiscal 4Q?

We're not even a full month into our fiscal fourth quarter. So there's not much to share at this point.

Got it. Got it. Okay. Supply chain, also a big, big topic over the last year. We've started to hear maybe some early signs of relief. Can you talk a little bit about what you're seeing on the supply chain front? And what's the latest in terms of -- I think you alluded to maybe some improvement as well on your last call, but any updates you can share there?

I think we said, some of the constraints got better as we went into the quarter. At the biggest level, right, the global supply chain with super optimized prepandemic for just in time, if you want to think of it that way, and you could get parts. You could sort of talk to your suppliers and that was all optimized. And I think what happened post pandemic as we're emerging as things have gotten more just in case, which means there's been more people filing on the demand envelope, which means many semiconductor companies are having to put out these 52-week lead times with semiconductor chips and put them on allocation. And so that is where the constraints come in. But what we have seen is a -- with some of the softening of demand in consumer segments of electronics, some of that capacity improvement is helpful for our business because of that softening in the consumer markets. But equally, some of the resilience measures that we took now for well over 12 months, whether it is finding alternate parts, suppliers, developing more strategic relationships with our suppliers and buying off the open market, sourcing strategies that we've deployed have enabled us to outperform in Q3 and sort of work through the constraints quicker. The predictability, which was an issue a year ago with our suppliers where you'd sort of hold your breath whether you get the parts on time, the predictability has gotten better as the quarter progressed in Q3. And as we look ahead, we continue to think that constraints are there, but I think our own ability to sort of work through those constraints and confidence in the guide that we provided in Q4 that enables us to look forward to maybe better supply situations as we go into next year.

Okay. One more high-level topic before we dig into some of the segments. Obviously, we're hearing more and more around potential recession for years heading into next year. How should we think about how your business would perform in a potential recession? Are there attributes you'd highlight to maybe better insulate revenue or margins that the Street may underappreciate?

Yes, I'll start with 2 things. First of all, on the topline, as Satish has already talked about some of the secular growth drivers that, while maybe not making us immune from macro, I think at least provides some sort of a buffer. So whether that's the ongoing 5G rollout, the 400- and 800-gigabit, the geopolitical situation on R&D, the re-onshoring of semi, the AV and EV pieces of auto, I think, are going to provide some production even on the topline to what most people think, if it happens, would be a short, but shallow type of macro correction. I think beyond that, we still maintain all of the kind of flexibility in our cost structure that served us so well in early 2020. And so what I mean by that, but the single biggest piece of that is that 100% of our employees have a portion of their pay that fluctuates with business performance. And so I don't need to take any action to trigger that. If business performance starts to wane in a macro environment, I get an automatic check up in the single biggest portion of my cost structure, right? About 25% of our sales still flows through an indirect channel, right? That provides flexibility. 50% of our manufacturing is outsourced. So we have these flexibility components that are systematic, if you will, and provide a strong buffer to -- on the bottom line, should we see some perturbations occur on the topline.

Neil, probably, the one thing that is also worth adding is, in our end markets, given how much exposure our portfolio has to R&D applications of our customers, our center-based view is any perturbation in short-term demand just -- it tends to push out demand, if not destroy demand. And that's what we saw in COVID. You saw in 2020 -- fiscal year '20, our orders only grew 2% and then followed by what is shaping out to be 2 consecutive years of double-digit order growth. So that's the base case assumption we have when we -- discussion with our customers around the secular growth themes that we've talked about, especially in R&D, nobody is canceling their long-term programs. I think people are holding to them because it is key to the long-term differentiation. So yes, it's probably one thing I want to add to it.

Let's dig into -- we talk a little bit about your background with CSG. Let's talk about commercial comps in particular. We'll get into ADG in a second. So record revenue growth, record revenue second straight quarter last quarter, although we still get the question, is the 5G cycle beginning to turn? Are we in the later innings? Where are we in the 5G cycle? And how should we think about the duration of this tailwind for Keysight?

Yes. I think -- Matt, I'll answer that more head on, but I think you've got to think about the commercial comms portfolio as being able to enable a number of the technology trends in that industry in both wireless and wireline. And all the way from silicon to cloud, there's so many innovations that's happening that we're engaged in. And 5G is obviously an umbrella term for the wireless side of the business, which continues to be strong for us. And as I've said before, near term, we are benefiting from all the C-band deployments that are scaling around the world, and we just had spectrum announced in India. So there's a lot of activity in India to ramp 5G. So all of that provides a near-term catalyst for us. Medium-term, the millimeter wave interest, which continues to be secular and growing, I think that deployments whenever that takes off could be another catalyst. And then we're equally energized by the applications that are happening with 5G technology, whether it's in automotive with C-V2X, whether it's in aerospace and defense, satellite technologies with non-terrestrial networks, these new applications, including ORAN, are providing new streams of innovation for Keysight to tap into. And many of them, we've already tested them, and they're in -- we're past the prototype phase. And we're actually recognizing meaningful revenue already, and we'll continue to grow big growth drivers for us over the long term. But yes, I try to think of it as portfolio that's balanced on both wireless and wireline evolutions, a multiyear roadmap that's ahead of all these technology trends. And so in that context, we feel really good about where our portfolio is positioned.

Okay. So the music is not stopping anytime soon, it sounds like.

Yes. No, we're pretty busy.

Okay. Okay. What about 6G? I mean we've heard some announcements. I don't want to jump that on. Obviously, it sounds like we've got a lot more room to run with 5G, but we've also seen some very, very early announcements around 6G. So I'm wondering at what point would you anticipate R&D into 6G being a little bit more of a material revenue driver for you guys?

Yes, we've already -- I think we've announced some of our collaborations with lead consortiums and with some companies around the world that are starting some early research in 6G. And we've repurposed some of our 5G platforms to address some early applications in the research phase. So we're already generating some revenue, which is good. But when I think about 5G as a technology and some of its goals, we're more focused on how to make the networks better. So it was very technology-focused, and obviously, that was great. But as we think about 6G, the bigger vision is around solving societal problems leveraging technology. So it is about sustainability, and especially on the energy front, it's a big imperative that's forming given how important energy sustainability and green technology is for the future of the planet. So there are multiple new technology that are being investigated, including use of AI in a cellular network for the first time. So, very exciting possibilities that are there. It's very early stages, but one that you could conclude that the complexity and the need to embrace that technology would be higher whenever that turns into an inflection and one where Keysight is obviously well positioned given our strength in 5G to continue that extension because you lead that industry to that extension.

Got it. So the other component within CSG is obviously the aerospace, defense and government ADG business. A little bit slower revenue growth, I'd say, maybe relative to comms in the ISG segment. Can you help us maybe unpack what you're seeing in terms of orders and underlying demand relative to some of that maybe more moderate revenue growth?

Yes, strong order. Again, we built backlog, I think, in Q3. And so we feel like, okay, revenue is a function of -- as we've said, it's a function of supply demand. The business of aerospace defense is -- 50% of it is obviously based in the U.S. and North America, and it depends on the budgetary flows. They don't follow a quarterly pattern necessarily. So we tend to look at it as a long-cycle business, measure success in terms of the program wins. We're having new applications we're launching. And just look at it over the long run, Matt, we're quite pleased that we've been able to do better than the GDP peg that we have for that business. And as I think about the future, what's interesting is with this geopolitical dynamic, I think the investments in technology from sovereign nations around the world, investments in research are going to only increase, and I think we'll be well positioned to be beneficiaries from that net investment.

And maybe to put a little bit of a timeframe on it. We've seen some headlines around the U.S. Department of Defense increasing spending with RDT&E. NATO obviously, I mean, I think not surprisingly will be planning on increasing defense budgets as well. So is there maybe a broader timeframe in terms of when that could start becoming more of a tailwind to growth for your business?

Well, it's already started, right? I think if you look at the performance of the business, we've done better than what we thought we would. If you just look at it over the long -- over the last 3 to 5 years in that business. And despite all of some of the geopolitical headwinds that have directly impacted that business because we can't do business with some customers around the world because they are on the DoC list. So despite that being in the baseline, we continue to outperform. But you look at the application set, whether it comes to quantum computing, security applications and cyber with respect to space and satellite, these are all new emerging areas of innovation that we're focused on which I think would find its way into the RDT&E line items, which should be beneficial to us.