Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal First Quarter 2023 Earnings Conference Call. My name is Jason, and I’ll be your lead operator today. After the presentation, we will conduct a question-and-answer session. This call is being recorded today, Tuesday, February 21, 2023 at 1:30 p.m. Pacific Time. I would now like to hand the conference over to our host, Jason Kary, Vice President, Treasurer and Investor Relations. Please go ahead. Thank you, and welcome everyone to Keysight’s first quarter earnings conference call for fiscal year 2023. Joining me are Keysight’s President and CEO, Satish Dhanasekaran, and our CFO, Neil Dougherty. In the Q&A session we will be joined by Senior Vice President of Global Sales and 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. Today’s comments will refer to non-GAAP financial measures. We will also make reference to 'core' growth, which excludes the impact of currency movements and acquisitions or divestitures 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. We assume no obligation to update them. Please review our recent SEC filings for a more complete picture of these risks and other factors. As a reminder, we are hosting our 2023 Investor Day on March 7th at the New York Stock Exchange. Management is also scheduled to participate in the Morgan Stanley Investor Conference on March 8th. And now, I’ll turn the call over to Satish.

Thank you, Jason. Good afternoon, everyone, and thank you for joining us today. Keysight delivered exceptional first quarter financial results, posting revenue and earnings above the high end of our guidance against a backdrop of moderating demand. Our performance and consistent execution demonstrate the resilience of our business, and despite the challenging macro dynamics, we believe Keysight is well-positioned to build on our success and expand our leadership across our end-markets. I’ll focus my comments today on three key headlines. First, we achieved strong financial results. Revenue was a first quarter record and grew 14% on a core basis, driven by strength in both business segments and across all geographies. We again demonstrated the durability of our financial model and delivered $2.02 in earnings per share. Second, we started to see a normalization of what has been a robust and prolonged period of investment by our customers. Over the past two years, significant demand for Keysight’s solutions resulted in a 15% compound order growth rate and a book-to-bill of 1.09. As demand slows in the near-term, Keysight’s exposure to multiple end markets, its differentiated portfolio, and our strong operating discipline positions us well to weather the current macro dynamics. Third, we remain confident in the secular, long-term growth trends across our markets. Our software-centric solutions strategy is well-aligned with the needs of our customers, which we expect will enable us to outperform the market. We look forward to providing you a more comprehensive update on our long-term growth strategies and financial objectives at our upcoming Investor Day. Now let’s take a deeper look at our first quarter results. Orders declined 13% year-over-year against a strong compare of 22% growth in last year’s first quarter. The slowing demand and business specific headwinds that we anticipated last quarter materialized largely as expected. These included the year-over-year impact of currency, our exit of Russia, and incremental China trade sanctions, which together contributed to a 6-point drag on the compare. We saw customers exercise caution in response to macroeconomic uncertainty. This was most notable among our largest customers in Commercial Communications, who were impacted by a sharp demand decline in consumer electronics and computing segments. They are restructuring and reassessing their near-term priorities as the industry digests inventory while at the same time maintaining investments across key, strategic programs. While the duration is difficult to predict, we expect these dynamics to weigh on our customers for at least the next couple of quarters. Despite macro challenges, revenue grew 10%, or 14% on a core basis. Strong execution and operational discipline resulted in a gross margin of 65%, operating margin of 30%, and earnings per share growth of 22%. Turning to our business segments, the Electronics Industrial Solutions Group revenue grew 19% and delivered double-digit revenue growth for the 10th consecutive quarter, which underscores the diversity of our industry exposure. In automotive, we achieved record revenue and strong double-digit growth across all regions. Sales of electric vehicles continued to grow significantly in 2022, further fueling investment in EV and AV technologies and manufacturing. This quarter we secured multiple strategic wins with large OEMs and Tier 1 suppliers across a breadth of applications such as 5G, autonomous driving emulation, battery and charging infrastructure design, and in-vehicle networks. To strengthen our position in this market and capitalize on this growing, decades-long opportunity, we continue to expand our portfolio of solutions. An example is our current collaboration with Jiyun Technologies to develop a high-efficiency, compact battery test system to help accelerate the launch of new electric vehicles. In general electronics, double-digit revenue growth was driven by continued strength in emerging verticals such as digital health and IoT. We also secured wins in advanced research, as R&D investment remains robust in quantum, photonics, and Beyond 5G. Semiconductor solutions revenue growth was driven by continued fab investments in new wafer capacity and advanced nodes. While the inventory adjustments are pacing demand, foundries continue to execute their longer-term plans to globalize their production. We see significant opportunities in this market and are investing in solutions for emerging semiconductor applications such as silicon photonics, high-power semis, and millimeter wave. Turning to our Communications Solutions Group, revenue grew 7%, with growth across both end markets and all regions. Commercial Communications revenue grew 11% on a core basis, to reach a record Q1 driven by ongoing, strategic investments in the communications ecosystem. We saw strength in 5G R&D and deployments, Open-RAN, and datacenter networking, with increased focus on 800 gigabit and terabit communications solutions. These programs remain a priority and are driving demand for Keysight’s first-to-market solutions. As a trusted advisor, we remain actively engaged with our customers as they adapt to the current macro environment. We recently announced our collaboration with Qualcomm to accelerate 5G non-terrestrial network communications for broadband in remote areas, and enable device makers to speed development and verification of 3GPP Release 17 compliant designs. We continued to support the progression of standards and submitted the first 3GPP Release 16 protocol conformance test, enabling new use cases such as private and industrial networks, and autonomous vehicles. Investment in early 6G research is underway and Keysight joined forces with 16 organizations to create 6G-SANDBOX, a pan-European testbed for 6G experimentation and validation of 5G-Advanced and 6G capabilities. Nokia recently selected Keysight’s sub-Terahertz testbed to validate D band and E band technology to accelerate R&D critical to 5G-Advanced and 6G use cases in millimeter wave and sub-terahertz frequency spectrum. We also announced the industry’s first and highest density network cybersecurity test platform, which provides data center network infrastructure and cloud providers with leading 400 gigabit Ethernet security validation capabilities. These solutions reinforce our leadership across wireless and wireline ecosystems. We are also looking forward to the Mobile World Congress in Barcelona next week. Keysight will be engaged with many customers and industry leaders, showcasing our solutions for advancing 5G standards including Release 17 and early research in 6G and intelligent automation. Turning to our government, defense, and aerospace business, record Q1 revenue grew 9% on a core basis, achieving its second highest revenue quarter driven by increased U.S. government spending, and strength in space and satellite, including new applications for non-terrestrial networks. We recently won a five-year contract with the U.S. Army who chose Keysight’s Field Fox handheld spectrum analyzer for field use. We expect U.S. government budget appropriations to ramp spending in new programs in the second half of this year. We also anticipate an increase in defense budgets worldwide, and growing investment in new technologies such as 5G, space and satellite, quantum, and advanced research. Consistent with our strategy, we continue to expand our software capabilities. We recently completed the acquisition of Cliosoft, whose data and IP management software tools enhance our portfolio of electronic design automation solutions. In addition, Eggplant’s test automation platform was recently recognized as a leader by The Forrester Wave. About one-third of total revenue, the growing mix of software and services is integral to the durability of our financial model. Keysight’s differentiation is a function of our software-centric solutions strategy, collaboration with our customers, and investments we are making to ensure that we address the most challenging technology needs of today and into the future. We are prioritizing high-conviction growth opportunities to solidify our competitive position for the long-term while at the same time accelerating initiatives to drive further efficiencies consistent with our financial model. We remain committed to creating long-term value for business stakeholders and positively impacting the global community. I’m proud that Keysight has been named to the Dow Jones Sustainability Index for the fourth year in a row. I’d like to thank all our Keysight employees for their dedication and relentless execution which drives our strong track record of performance and is a testament to Keysight’s Leadership Model, our values, and to our people. With that, I’ll now turn the call over to Neil to discuss our financial performance and outlook.

Thank you, Satish, and hello everyone. Q1 was a strong quarter and a solid start to the year. We delivered revenue of $1,381 million, which was above the high end of our guidance range, and grew 10%, or 14% on a core basis. As we anticipated, macroeconomic uncertainty moderated demand in the first quarter. Orders of $1.3 billion were down 13%, or 10% on a core basis. Even with revenue outpacing orders by $80 million, we ended the quarter with over $2.5 billion in backlog. Turning to our operational results for Q1, we reported gross margin of 65% and operating expenses of $492 million, resulting in an operating margin of 30%. We achieved net income of $363 million and delivered $2.02 in earnings per share, which was above the high-end of our guidance. Our weighted average share count for the quarter was 180 million shares. Moving to the performance of our segments, our Communications Solutions Group generated revenue of $939 million, up 7%, or 10% on a core basis. Commercial Communications revenue of $629 million was up 8%, with double-digit revenue growth in the Americas. Aerospace, defense and government revenue of $310 million benefited from increased U.S. government spending, which we believe will continue to ramp through FY23. Altogether, CSG delivered record gross margin of 67% and operating margin of 29%. The Electronic Industrial Solutions Group generated first quarter revenue of $442 million, up 19%, or 23% on a core basis, with double-digit revenue growth in automotive and general electronics, demonstrating the diversity of our markets. Growth was strongest in the Americas and Europe. EISG reported gross margin of 61% and operating margin of 32%. Moving to the balance sheet and cash flow. We ended our first quarter with $2.2 billion in cash and cash equivalents, generating cash flow from operations of $366 million, and free cash flow of $306 million, or 22% of revenue. Share repurchases this quarter totaled approximately 700,000 shares at an average share price of $176, for a total consideration of $125 million. Now, turning to our outlook. We’re navigating the same evolving macro and industry dynamics that others have noted. As Satish mentioned, we expect it will take at least a couple of quarters for customers to work through their near-term challenges. If the current demand environment persists through our fourth quarter, we would expect to deliver low single-digit revenue and earnings per share growth for the year, achieved through steady backlog conversion, strong cost discipline, and the flexibility of our financial model. Turning to our second quarter guidance. We expect revenue to be in the range of $1,370 million to $1,390 million, and Q2 earnings per share to be in the range of $1.91 to $1.97, based on a weighted diluted share count of approximately 179 million shares. While near-term uncertainties are moderating the demand environment, Keysight’s secular, long-term growth trends remain intact. Our differentiated, first-to-market solutions, durability of our financial model, steady cash generation, and strong balance sheet position us well to deliver on our commitments to our customers and shareholders. We look forward to sharing more with you about the compounding nature of our business at our upcoming Investor Day. With that, I will now turn it back to Jason for the Q&A.

Thanks, Neil. Jason, can you give the instructions for the Q&A, please?

Our first question is from Mark Delaney with Goldman Sachs.

Yes. Good afternoon. Thank you very much for taking the question. I was hoping, first, if you could elaborate a little bit more on the comments on orders. It seems like it’s particularly impacting the Commercial Communications business and maybe certain other areas are doing a bit better. But if you could offer a bit more on where you’re seeing the orders and where perhaps you’re seeing some moderation from customers?

Yes, hi Mark. First, our customer engagements remain very strong, and we experienced robust shipment activity this quarter, which is reflected in our strong revenue performance. Our backlog stands at $2.5 billion, with high-quality orders and low cancellations. To provide context on the demand normalization, as mentioned in the last earnings call, we faced some business-specific headwinds of roughly 6 to 7 points. However, compared to last year, our performance was up 22%. In the Commercial Communications sector, we noticed a pullback from our top customer, particularly in the wireless segment, due to macro challenges and inventory digestion in the smartphone industry. Conversely, there has been increased activity in the wireline sector as customers invest in 400 gig, 800 gig Ethernet, and terabit solutions. In our aerospace and defense business, we're observing a positive trend in the U.S. as budgets are approved and spending on programs resumes. Additionally, all prime contractors are showing stronger backlog positions, giving us a positive outlook. Our Industrial business also demonstrates resilience, supported by research spending in various countries, and strong investments in automotive with electric and autonomous vehicles, as well as next-generation semiconductors. Considering all this, we remain confident in our portfolio differentiation and are actively engaging with customers to navigate this environment effectively.

Thanks, Satish. That’s very helpful. My other question was on the cost controls, and the company spoke about being disciplined. Were you alluding more to the variable nature of your cost structure, and that will moderate spending depending on what demand ultimately does this year, or are there more specific steps that Keysight is planning to take on cost controls? Thank you.

Yes. Mark, as we mentioned, always that we have this variable cost structure and operating model, that’s the first leg of our resilience from a financial perspective. But we’re always looking for dynamic resource allocation opportunities, especially in a market like this, where we see some of our customers pull back. We redeploy to other customers who need these technologies so that we’re maximizing. So that’s part of that discipline that I referenced. And we always have on deck operational efficiency programs as part of the Keysight leadership model. And we’re remaining focused on that, in some cases, even accelerating that. That should help us offset the inflationary impacts to the P&L as we are all faced with right now.

Our next question comes from Mehdi Hosseini with SIG.

I want to go back to booking a backlog. You guys have been very clear for a couple of quarters that post-COVID we’re going to have to go through a backlog normalization. And I want to get some more color from you is, is there any way you can separate or differentiate the backlog normalization from end market demand weakness, especially in the smartphone area that you highlighted?

Yes. Maybe I’ll just start, and then Neil can add. I’d say that if we look at our end markets and if you take a look at the commercial comps, especially in the wireless side, the top customer pull back is definitely macro related and related to the inventory exposure that they have, which has been widely talked about. But if we look at the base customer spend, it remains pretty strong. So, that’s as far as that end market is concerned, but we start to look at aerospace defense and our industrial exposure, which continues to provide us top line diversity. And I think that will play out as we go through the year as well. Neil, specific to our backlog position?

Yes. I would like to add that regarding the supply chain, there are still some areas where we are constrained. However, in other areas, we’ve observed a significant improvement in product availability and a trend towards normal lead times. What we are experiencing aligns with our expectations. In many cases, we have customers for those products whose scheduled shipments are now pushed out an additional quarter or more. As our lead times have shortened, they currently do not need to place new orders until they receive the products that are already in backlog. Previously, customers would place orders early to secure their place due to long lead times. Now that we are seeing lead times normalize, combined with macroeconomic uncertainty, there is less motivation to order early, which is putting some additional pressure on the order line.

Sure. As a follow-up, you mentioned $1.3 billion in new orders. Can you help clarify the R&D portion or the strategic investments included in that figure? I'm trying to understand the potential downside risks in booking activity moving forward. Is $800 million per quarter a reasonable worst-case scenario, or can you provide any insights that would be helpful?

Yes, thank you, Mehdi. The environment remains highly uncertain. We've noticed that customers are typically solidifying their demand and budgets at the start of the year, but concerns are causing them to delay those decisions until later. This uncertainty persists. In terms of spending, particularly in commercial communications, we are observing a pullback in manufacturing expansions compared to customers' R&D plans. That seems to be the overall trend. Looking at the ISG business, specifically in semiconductors, customers are not reducing their investments in next-generation semiconductor capacity, such as 5-nanometer and 3-nanometer technology. They may be scaling back on some of the 7-nanometer initiatives they had planned. The emphasis on next-generation technology is still very strong. I'll have Mark share more insights on customer dynamics he's experiencing from a sales standpoint.

Yes. To answer your question directly, the mix during the quarter was still heavily focused on R&D. Satish mentioned that the reduction was less significant in commercial communications compared to the manufacturing side. We have previously discussed our six-month funnel, which provides a strong indication of future demand. This has been incorporated into our guidance and has normalized following the significant effects we observed in the first quarter. Looking ahead six months, the demand signals appear to be fairly consistent with what we experienced in Q1.

Mehdi, the other point with regard to your comment on the downside risk, right? I’ll say that we’ve done a lot of work to enter into more of the R&D markets of our customers. That still remains a priority for us. We’ve also done quite a bit of work to diversify this business to expand into industrial end markets, aerospace defense, and auto in particular. And finally, through our sales footprint, we’ve done work to attract new customers, and that remains a critical priority for us. I remain confident that all of these actions will enable us to outperform in this environment as well.

Our next question comes from Meta Marshall with Morgan Stanley.

I have a couple of questions. You mentioned Open-RAN millimeter wave and some areas of investment. As we look at the communications business, could you share what the main revenue drivers are as we approach 2023? Is it Open-RAN, millimeter wave, or 6G? What is the overall strength of that business? As a follow-up, you talked about implementing stronger cost discipline to offset lower demand. Can you provide insight into where investments are still being made and what extent the cuts will be as we progress through the year? Thank you.

Yes, thank you, Meta. We are deeply committed to continuing our innovation and enhancing our portfolio. Our research and development investments are guided by collaborations with our customers, and we are optimistic about this approach. Any pullbacks we experience are likely to be short-term delays in R&D spending, which we anticipate will recover as our customers navigate their inventory challenges. Regarding 5G, our R&D roadmap is intact. Our customers have a multi-year strategy and are consistently investing to achieve it. While we have made significant strides in 5G deployments, there are still approximately 1 billion subscribers worldwide, with plans to expand this to 5 billion over the next five years. This indicates that there is substantial deployment activity ahead, particularly in India and other regions leading this charge. The advancement of standards, which is crucial for our R&D, continues strongly with Release 16 and Release 17 progressing toward Release 18, which will represent 5G advanced. Opportunities for investment exist in areas such as non-terrestrial networks, new features like RedCap for IoT applications, and the expansion of 5G into new verticals. We are focused on differentiating ourselves in collaboration with Open-RAN. Overall, the industry roadmap is robust, and our competitive edge remains strong in these markets.

And then, Meta, I’ll just address the cost discipline question. So, first and foremost, I’d like to just emphasize that we are continuing growth-oriented investments that are going to drive this business forward in the future. We’re very clear about what those priorities are internally and we’re keeping our foot on the gas with regard to our most important growth-driven investments. That being said, I like the way Satish characterized it, right? We always have onset a tap of efficiency gains that we’re looking to operate on as part of our continuous improvement culture. And given the environment that we’re in with pressure on the top line, coupled with not just inflation, frankly, but signs that the dollar is going to backtrack on some of the strengthening that we saw last year, which will also put pressure on our foreign currency spending. We felt it was prudent for us to take actions to accelerate some of that efficiency. So, it’s across the P&L, but we are not putting future growth investments at risk.

Our next question comes from Samik Chatterjee with JP Morgan.

I'd like to start by asking about orders. Can you discuss the trends of orders throughout the quarter? Specifically, I'd like to know if you observed any decline as the quarter closed, especially considering that customers may need some time to adjust over the next few quarters. Also, I noticed you've mentioned that electronics orders are performing better than communication orders overall. This seems somewhat surprising to me, as I had thought communications would be more aligned with R&D compared to EISG. Could you clarify this situation and explain why communication is not holding up as expected if R&D is generally more stable? I have a follow-up question as well. Thank you.

Sure, this is Mark. I’ll address the first question about the linearity of orders. We experienced about two-thirds of our orders coming in after the second month, including a strong finish at the end of FY22 and our fourth quarter. In December, we saw a nice rebound, with the last quarter accounting for approximately 34% of our total bookings for that period. The flow of business was quite steady. On the electronic industrial side, as Satish mentioned, there is ongoing demand for next-generation process technologies in our semiconductor business, driven by long-term growth trends we have been discussing for some time. The activity and focus on next-generation automobiles, especially electric vehicles, are ramping up. This is a transformation that will take about a decade. The sales of electric vehicles last year increased compared to internal combustion engine vehicles, indicating a long-term trend. I was particularly surprised by the resilience of our general electronics business, especially in sectors we are focusing on, such as digital health care, advanced research, and education. While some areas are influenced by broader GDP trends, with the PMI remaining below 54 for five or six consecutive months, the three segments below EISG have shown resilience and continued investments in next-generation technologies.

For my follow-up and perhaps to shift the conversation a bit, there is a competitor of yours currently undergoing a strategic review process with interest from several parties regarding an acquisition. I'm not asking you to comment on the interest in that company specifically. However, how should we consider the benefits to Keysight from scaling the business significantly from this point onward? Also, what level of debt leverage on the balance sheet would you be comfortable with if attractive opportunities arose that are more apparent?

Thank you, Samik. You are correct. We do not comment on specific opportunities. However, we are confident in our business and its potential for generating cash. Our strong free cash flow performance reflects this. Consequently, we maintain a consistent approach to capital allocation focused on organic growth, M&A when it makes sense, and returning capital. Regarding M&A, we have been very patient and disciplined in the opportunities we consider. We evaluate hundreds of companies following thorough market assessments and have completed about 20 acquisitions so far. Each has been executed with our strategy in mind, considering how we can add value to the target and ensuring a strong fit, while also prioritizing returns for our shareholders. We will continue to uphold these standards and remain disciplined.

Our next question is from Chris Snyder with UBS.

So back on the conference call in November, the company talked about book-to-bills approaching a more normalized 1.0x. The quarter came in a bit below that at 0.94. So, were orders in the quarter softer than you would have expected back in November? Or for book-to-bills to improve as the year goes on and kind of reach that more normalized average of 1.0x for the full year?

Yes. I mean, if you go back to the November quarter, we talked about 8 points of specific headwinds that we were facing from currency and from China, Russia, those things, and that we expected that we were also recognizing macro softness on top of that or anticipating macro softness on top of that. So, by and large, I’d say the quarter came in largely in line with our expectations. It’s obviously hard to put a quantification on macro. I mean, looking forward, as Satish has said, it’s very difficult to call at this point. We’ve attempted to give you some parameters with which to think about the business. Mark has commented that in our funnel, which looks out over the next couple of quarters would indicate demand that’s more or less in line with what we just saw in the first quarter. And then, I did state in my prepared comments that if that kind of order trend remain in place for our entire remainder of our fiscal year, we’d expect to still be able to deliver low single-digit revenue and EPS growth. So, we’re taking it one quarter at a time, but that should hopefully give you some guardrails with which to think about the business.

Thank you. I appreciate that. And then just kind of staying on orders for fiscal Q1, is there anything or color you could provide around how orders in China did during the quarter, given a lot of the disruption over there? And also government and defense business orders, just given some of the budgeting resolution processes going on? Thank you.

Sure. This is Mark. I’ll address both of those points. Like everyone else, we encountered the unexpected surge from COVID, along with some additional trade restrictions in December. We observed a decline in orders from China, although they actually increased sequentially, indicating the unusual seasonality we experienced. Despite some of the declines we anticipated, I was pleased with our response. This aligns with our previous discussions about our capability to adapt to new opportunities and the diversity of our customer base in China, which remains a strong area for us. This includes automotive, where the business saw an increase. New use cases for 5G in private networks continue to show growth from an industrial perspective. We also see potential in mature process technologies for semiconductors. As the economy starts to normalize and possibly reopen in the second half, we will monitor the situation closely. In aerospace defense, as Satish mentioned earlier, we experienced robust order growth in the U.S. This is a result of the budget being approved earlier this year than last. What occurred in Q1 was not the initiation of new programs but rather the resumption of multiyear programs that had been delayed due to continuing resolutions. We expect increased spending to follow as we progress through the upcoming months and quarters, benefiting from the record high RDT&E budget. Internationally, considering the geopolitical climate, we anticipate sustained long-term demand for defense modernization, positioning us well to seize those opportunities.

Yes. Just maybe to add a comment to Mark, the space and satellite also continues to inflect for us in the aerospace defense business, and is showing some momentum there with customers, too.

Our next question comes from Aaron Rakers with Wells Fargo.

I’d like to revisit the order and backlog situation. Neil, last quarter you mentioned that the backlog was about four or five weeks elevated compared to usual. Can you update us on that? Also, does your low single-digit growth assumption indicate a return to normal backlog levels over the year?

Yes. It’s a great question. So obviously, revenue outpaced orders by about $80 million within the quarter. You can do the math on it. But if we see a similar environment persist for the remainder of the year, which is, again, in line with the guardrails what I put out there, we’d burn $300 million plus of that kind of abnormal backlog. So, it may not get us all the way home, but it would get us a significant chunk of the way towards normalization of the backlog over a multi-quarter period. We always knew it would take multiple quarters to normalize the backlog. And while this is just one scenario, I think it’s not out of line with our expectations.

Okay. That's helpful. I have a quick follow-up regarding the semiconductor business, which continues to perform well. I'm not sure of the answer to this question, but I want to ask if there are any disruptions. I've heard that a supplier in the semiconductor supply chain experienced some cyber-attack issues. Is that impacting your business at all?

No, not at all. For us, we serve the wafer stage, which is on the front end. It takes a longer lead time from our fabs to put capacity. And we see customers sticking with their plans for 5-nanometer and below. And equally, we’re also quite pleased with the progression we’re making to further add more applications into our solution stat, whether it is high-power applications for certain chips or silicon photonics or millimeter wave. So we continue to build that portfolio out.

Our next question comes from Jim Suva with Citigroup.

My first question is for you, Neil. You mentioned that as the year progresses, if everything goes according to plan, you're anticipating some sales growth, which I believe you indicated would be in the low to mid-single digits. You also mentioned EPS growth. Are you expecting the EPS growth to be positive or within the same range as sales growth? Typically, earnings per share tends to grow at a higher rate than sales growth. I have a follow-up after that. Thank you.

Yes. Firstly, we are not providing guidance for the year. We mentioned that the environment is highly uncertain and it is challenging to predict. However, if demand remains consistent with what we observed in the first quarter for the rest of the year, we anticipate low single-digit growth in both revenue and EPS. Our model suggests higher revenue growth, supported by 40% operating leverage, which could lead to double-digit EPS growth. In a scenario where revenue growth is lower, combined with the current inflationary environment, we would expect low single-digit growth for both revenue and EPS, assuming that our order levels stay similar to those seen in the first quarter.

Great. My follow-up question is about the incremental trade restrictions against China that were implemented in December. When considering your commentary for 2023, if everything remains consistent, what is the sales impact of these additional restrictions? Is this what you were referring to in your prepared remarks regarding the 3 to 4 points or 6 to 7 points of growth impact? Can you elaborate on how the trade restrictions affect your outlook? Thank you.

The new trade restrictions in China that started in December are expected to create an additional 1 to 2 points of headwind for us in the long term. In the previous quarter, I mentioned that we anticipated an 8-point headwind from China, Russia, and foreign exchange. By the end of the quarter, we realized that what we expected to be 8 points was actually around 6.5, so we estimated it to be between 6 and 7, primarily due to a slight strengthening of the dollar, which made the foreign exchange impact less severe than we initially thought. The impact from China was also somewhat less than we anticipated.

Our next question comes from Matthew Niknam with Deutsche Bank.

Maybe just a follow-up on that last one. On the Analyst Day, I’m just wondering any initial thoughts on what we could expect on March 7th in terms of just updates to longer-term targets? And then just on the M&A backdrop, I’m just wondering, what’s the latest you’re seeing in terms of opportunities and valuations. And I know in the past you’ve been focused on some smaller size software deals. I’m just wondering if that’s still the focus or maybe whether you’re open to larger deals, just considering the pullback in private market valuations. Thanks.

Yes. Thank you. I look forward to sharing the forward-looking view on the market fundamentally at the Investor Day. Across our end markets, we see innovation accelerating. And I think we’ll lay out Keysight’s strategy to go into set those exciting long-term opportunities. So that’s number one. But I think with regard to M&A, clearly, if you look at how we’ve grown, we’ve been disciplined in actioning M&A of all sizes. You’ve seen us do Anite and Ixia, slightly larger scale and then a lot of technology tuck-ins, which have helped us complete the workflow and actually create greater value for customers and also expand our margins in the process. So from that perspective, we remain active in exploring new markets and targets as well. But again, as I mentioned before, we have strong strategic and financial hurdles that we have to meet as gates before we go ahead and transact the business. On the valuation front, on the margin, we think the valuations are likely to come in as more of the market reality sets in with a number of the firms. So. And with the strong balance sheet and cash position, we remain active in exploring opportunities.

Our next question comes from Adam Thalhimer with Thompson Davis.

Congrats on the Q1 beat. First question on cancellations. You said that they’ve been low to date. I guess I just wanted to gauge your level of concern that that could get worse.

Yes. We’ve had no increase in our cancellation rate. So we continue to believe the quality of our backlog is very high.

And then I guess I’m just curious, how does this downturn and what you’re seeing so far compare to prior downturns? Because amazingly, you guys have been public almost 10 years, but we haven’t had a prolonged recession during that period.

Yes, I think I’ll take this. Satish here. Every recession brings a unique environment. After experiencing a couple of very strong growth years, some normalization was bound to happen. We are observing a pullback from certain customers due to inventory excesses in specific markets. However, our portfolio position is stronger than ever because of our focus on solutions. Our business model is much more robust today, with over 33% of our business coming from software and services, which adds resilience. We also have a strong operating model that helps us navigate market fluctuations. Additionally, we started the year with a solid backlog position. From these perspectives, the situation is different. Moreover, our gross margin remains strong at 65%, and with the operational model we have in place, we are confident in our ability to maintain that resilience.

Our next question comes from Rob Mason with Baird.

Satish, frankly, I’ll follow up your comment with a question just around the software orders in the quarter. I kind of inferred that they remain resilient. But as you think about where you’ve seen some challenges in Commercial Communications, to the extent that there’s a slowdown in renewals, or is that something that hits your radar screen as you see some of the headcount reductions take place in the tech sector? Just how you defend against that?

Yes. I think we have an incredibly sticky business with our customers, and we’re not seeing them pull back on renewals. Obviously, new purchases are taking longer, as Mark alluded to earlier. But I think even in the Commercial Communications sector, we have two businesses, right, wireless and wireline. We’re seeing stronger pullback from customers in the wireless side of the equation. The wireline customers continue to innovate. You see some of the trends in data center and cloud that are playing out. Need for faster data rates is important. Also in lieu of all of the activity that’s going on around AI, there’s a greater need to optimize the workflows of our customers. So, that part of the opportunity continues to remain stronger on a relative basis. I’ll just have Mark make any comment on...

Yes, Rob, to answer your question, Satish did a great job. I want to point out that we didn’t experience the same pullback in software as we saw in other areas of the business. In fact, our renewals increased, and our growth from subscriptions and enterprise agreements stayed consistent. This aligns with what we expect from a business that offers continuous value in a subscription model, which really benefited us this quarter.

Sure. Is that possibly a follow-up question regarding the influence that seems to be a trend over the past two quarters, where the gross margin in the Commercial Communications segment is significantly stronger in the first quarter and then appears to moderate in the second quarter? Is that still the expectation or the dynamic at play?

Could you repeat that? I’m sorry.

Yes. Generally, the CSG group's gross margins tend to be much stronger in the first quarter compared to the rest of the year, at least based on the last couple of years. Is that the expectation for this year as well?

Yes. I mean I don’t think you can draw any conclusions looking at historical sequential gross margin data as to what to expect. At least as I would think about it, any perturbations that may have appeared to have repeated have to be more coincidental than systematic.

And our final question is from David Ridley-Lane with Bank of America.

The typical seasonality is for a nice sequential uptick in EISG in the second quarter. Lot of the commentary on the call has been that ESG remains pretty strong. I mean, within your second quarter guidance, should we expect kind of that historical sequential pattern in EISG?

Yes. I mean all I would say is our sequential guide right now takes a look at our large backlog, looks at the schedule of shipments, looks at the incoming funnel. And obviously, we’re going to rely on a portion of incoming orders to turn into revenue within the quarter. And so we have a high degree of confidence in our ability to deliver to the number that we’ve put out.

Got it. On EISG, the trend in gross margin has been a bit softer over the last few quarters. That being said, operating margin expansion has continued to be quite good. I'm just wondering if there is something in the mix or other factors that you could point out to help explain the gross margin trend.

Yes. Across our businesses, we are focused on creating value for our customers, and the expectations for that value increase over time as we offer better solutions and content. This leads to higher software contributions, which improves our gross margin, as seen in our CSG business with a 67% gross margin. We aim to further enhance that. In the EISG segment, while there is somewhat less software content and a traditionally greater focus on manufacturing offerings, our commitment to developing solutions remains strong. In fact, we are incorporating more software into our semi-manufacturing test systems and providing additional analytics capabilities, which has seen robust customer interest. Therefore, as we move beyond the inflationary pressures from the supply chain and other factors we've discussed, I expect to see improvements in margins and look forward to sharing more details at the Investor Day.

There are no more questions, so I’ll pass the call back over to the management team for closing remarks.

Yes. Thank you, and thank you all for joining. Keysight delivered another strong quarter, revenue up 10%, strong gross margins at 65%, operating profit 30%, free cash flow of greater than $300 million. And we continue to remain focused on actively collaborating with our customers across the multiple end markets we serve as they navigate these dynamic conditions, which gives us the confidence in our ability to outperform. Again, we have a diversified end market exposure, strong solutions portfolio that’s growing, strength of backlog, strong cash position, and a strong balance sheet. All of these enable us to invest to realize our long-term growth strategies. But we’re doing so with the fiscal discipline and prudent operational initiatives that we have in place. We look forward to seeing you all in New York on March 7th, and I’m excited to share the future growth strategy moving forward. Thank you.

That concludes the conference call. Thank you for your participation. You may now disconnect your lines.