是德科技 (KEYS) 2023 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Third Quarter 2023 Earnings Conference Call. My name is Cole, and I'll be your lead operator today. (Operator Instructions) This call is being recorded today, Thursday, August 17, 2023 at 1:30 p.m. Pacific Time.

I would now like to hand the call over to Jason Kary, Vice President, Treasurer and Investor Relations.

Please go ahead, Mr. Kary.

Thank you, and welcome, everyone, to Keysight's third quarter earnings conference call for fiscal year 2023. Joining me are Keysight's President and CEO, Satish Dhanasekaran, and our CFO, Neil Dougherty, and the Q&A session will be joined by Chief Customer Officer, Mark Wallace.

The press release and information to supplement today's discussion are on our website at investor.keysight.com under the Financial Information tab and quarterly reports.

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.

Lastly, management is scheduled to participate in upcoming investor conferences hosted by Deutsche Bank, Goldman Sachs and Citi.

And now I will turn the call over to Satish.

Good afternoon, everyone, and thank you for joining us today.

Keysight reported solid results in the third quarter, demonstrating the strength of our portfolio and the resilience of our financial model. We are executing on our strategy and delivering on our commitments to customers and shareholders in a challenging macro environment.

My comments today will focus on 3 key headlines. First, we delivered another quarter of strong financial performance, demonstrating Keysight's diversified portfolio, strong execution and operating discipline. Third quarter revenue was in line with our expectations while record earnings per share exceeded our guidance range.

Second, while orders came in at the low end of our expectations, we saw positives and steady customer R&D spending and continued stability in commercial communications, growth in aerospace, defense and government and growth in our automotive, EV and AV solutions, partially offsetting incremental softness in EISG in Asia, primarily related to semiconductor and other manufacturing. This backdrop has tempered our near-term expectations for orders and revenue. We have factored this dynamic into our outlook for Q4, while now expecting full year EPS growth of 7%.

Third, despite the near-term challenges, Keysight's diversified business, differentiated solutions and durable operating model give us confidence in our ability to capitalize on the long-term secular growth trends of our markets as well as outperform in a variety of market conditions.

Now let's take a deeper look at our third quarter results. While orders declined 15%, revenue of $1.38 billion was up 1% on a core basis and a record for the third quarter. Our differentiation and strong execution resulted in gross margin of 66% and record operating margin of 31%. We delivered $2.19 in earnings per share, which was an all-time high.

Turning to the demand environment. We continue to see steady investment in strategic R&D programs in commercial communications, aerospace, defense and government and automotive EV solutions. In fact, over the past year, we have seen a meaningful growth in large, long-term customer commitments related to strategic programs, particularly in automotive and ADG. We view this as an important validation of our strategy. It puts us in a strong position in key emerging technologies and positions us well for future growth.

Demand was incrementally weaker in Asia this quarter as customers deferred manufacturing-related spending in semiconductor, general electronics and automotive markets, in many cases, well into next year. Taken together, the increase in our customers' strategic program investment, combined with soft near-term demand environment, is moderating revenue in the fourth quarter, which Neil will discuss in more detail.

Turning to our business segments. Electronic Industrial Solutions Group revenue grew 14% to another quarterly record and the 12th consecutive quarter of double-digit revenue growth. The strong financial performance was driven by double-digit growth across all markets and regions. EISG orders in the third quarter trended lower, particularly in semiconductor and manufacturing. Our customer engagements remain high as they plan for and continue to invest in key long-term strategic initiatives.

In semiconductor, despite a near-term pullback in capital spending for wafer capacity, the industry is marching forward in planning for a strong future demand environment. In the near term, customers are prioritizing new applications such as silicon photonics to address the AI demand. As a result, this quarter, we did see significant slowdown in our new wafer test solutions, while demand for Keysight silicon photonics test and proprietary interferometer systems remained high. We expect these dynamics to continue over the next few quarters.

In automotive, investments in EV and AV technologies continued to be strong. This quarter, we secured a third strategic win with another large European OEM to supply an EV battery test system that includes our PathWave lab automation software. This program will be implemented in 2025, and we're quite excited to be working with industry leaders and supporting their goals.

To address customer needs for wireless tracking, diagnostics, and connected vehicle communications, Keysight also announced support for automated RF testing for Autotalks C-V2X chipsets on our PathWave Test Executive Software Platform.

In general electronics, the growing collaboration between universities and companies is driving further investment in our solutions for advanced research. We're also expanding on our customer engagement in visual health solutions to support the growing digitization and connectivity requirements of this industry.

Turning to Communication Solutions Group. Revenue declined 5%, while the overall stable demand environment continued quarter-to-quarter. Aerospace, defense and government revenue grew 11% with strong demand from U.S. government and primes. Keysight's differentiated signal generation and threat scenario emulation capabilities led to a large U.S. Air Force contract in Q3. We also won a key contract from leading Canadian prime contractors for electromagnetic spectrum operation application. In addition, the demand for our radar and defense modernization solutions grew robustly as prime contractors placed orders for systems that support their delivery goals in 2024 and beyond. Government research demand and investment in 5G and 6G continued as well.

Commercial Communications revenue declined 12% due to cautious spending by customers in weaker manufacturing activity in smartphone, PC and component supply chain. Customer engagements remain strong with R&D investments in key technology to support 5G and 6G AI ML-driven high-speed data center networking and satellite communications. Demand for our wireline applications improved sequentially driven by cloud provider and hyperscaler investments as they design their networks for AI and ML workloads.

Enterprise customer and key service provider investment was steady, driven by increased digitization, heavier network loads and rising cybersecurity concerns.

In wireless, 5G standards are progressing, and we saw steady R&D investment in Open RAN, satellite, non-terrestrial networks and 5G RedCap Release 17 capability targeted at industrial and IoT applications. Early 6G engagements continued this quarter. We enabled the University of Stuttgart, to advance 6G integrated circuit research with our sub-terahertz solutions.

Keysight also led the agreement between the 6G-SANDBOX Consortium and the European Space Agency to further research to integrate terrestrial 5G/6G technologies and satellite networks of the future.

This quarter, we continue to strengthen our technology leadership in the industry and enable our customers' innovation. For example, we extended our flagship network analyzer portfolio by introducing industry's first integrated platform with vector component and analysis capabilities for power amplifier and component design applications. We also announced industry's most comprehensive multi-speed Ethernet performance platform, supporting data center interconnects up to 800 gigabit Ethernet that are critical for data-intensive applications such as AI.

And lastly, Keysight enabled 3GPP protocol conformance validation for Release 17 non-terrestrial networks and is continuing to partner with new satellite operators like Skylo to accelerate the deployment of satellite networks.

Software and services remain an integral part of our solution strategy and again accounted for 1/3 of total company revenue. Overall, software and services revenue grew year-over-year, reflecting the continued expansion of our software-centric solutions. We remain confident in the long-term secular growth of software-intensive R&D applications, particularly earlier in our customers' development process.

In line with this trend, and the software system simulation opportunity that I laid out at our March Investor Day, this quarter, we announced our intent to acquire ESI Group, a leader in virtual prototyping solutions for the automotive and aerospace markets. The addition of ESI broadens our software capabilities into physical simulation and furthers our strategy of moving upstream into earlier stages of our customers' design cycles.

Keysight's technology leadership and deep collaboration with industry players remains a significant competitive advantage. Despite current macro uncertainty, we see continued investments in R&D, driven by multiple waves of technology innovation and broad-based industrial digitization and connectivity needs. While continuing to invest in these long-term secular growth trends, we remain disciplined and have driven incremental cost efficiencies throughout the organization this year.

Our current guidance expectations are to finish the fiscal year 2023 with 7% EPS growth on 1% revenue growth. We believe this financial performance exemplifies the strength of Keysight's differentiated first-to-market solutions portfolio, our durable and resilient business model and our winning culture, which all together positions us well for continued market outperformance.

With that, I'll turn the call to Neil to discuss our financial performance and outlook.

Thank you, Satish, and hello, everyone.

We delivered solid financial performance in Q3. Revenue of $1.382 billion was just above the midpoint of our guidance range, flat year-over-year and up 1% on a core basis. Orders of $1.244 billion declined 15% on a reported and core basis. We ended the quarter with $2.3 billion in backlog.

Turning to our operational results for Q3. We reported gross margin of 66% and operating expenses of $478 million, resulting in record operating margin of 31%. We achieved net income of $393 million and delivered record earnings at $2.19 per share.

Our weighted average share count for the quarter was 179 million shares.

Moving to the performance of our segments. Our Communications Solutions Group generated revenue of $918 million, down 5% on a reported and core basis. Commercial communications revenue of $611 million declined 12% while aerospace, defense and government revenue of $307 million was up 11%, driven by increasing defense budgets worldwide and investments in technology modernization.

Altogether, CSG delivered gross margin of 68% and record operating margin of 30%. The Electronic Industrial Solutions Group generated record revenue of $464 million, up 14% or 15% on a core basis, with double-digit revenue growth in automotive, general electronics and semiconductor. EISG reported gross margin of 62% and operating margin of 34%.

Moving to the balance sheet and cash flow. We ended our third quarter with $2.6 billion in cash and cash equivalents generated cash flow from operations of $241 million and free cash flow of $196 million or 14% of revenue. Share repurchases this quarter totaled approximately 930,000 shares at an average share price of $162 for a total consideration of $151 million.

Now with regard to our outlook. Exiting the quarter, and as Satish mentioned, the demand environment was mixed with areas of stability and growth, partially offsetting pockets of the incremental softening. In addition, the composition of our order mix has changed over the past year. Our ability to deliver differentiated solutions and innovate at the pace of our customers has resulted in meaningful growth in strategic long-term customer commitments, which will deliver high-quality revenue over multiyear periods. These commitments were approximately 2% of orders in Q3 year-to-date last year and are approximately 8% of orders year-to-date this year.

Turning to our fourth quarter guidance, which incorporates these factors. We expect revenue to be in the range of $1.290 billion to $1.310 billion. Full year revenue at the midpoint of our guidance is $5.5 billion, representing 1% growth. We expect Q4 earnings per share to be in the range of $1.83 to $1.89 based on a weighted diluted share count of approximately 179 million shares. Full year earnings per share at the midpoint of our guidance is $8.19, representing 7% growth.

As we look to next year, with the capitalization of R&D, the pending increase in the GILTI tax rate on offshore earnings and efforts by the OECD to establish a global corporate minimum tax rate of 15%, we now estimate that our non-GAAP tax rate beginning in fiscal year 2024 will be in the range of 15% to 17%.

With that, I will now turn it back to Jason for the Q&A.

Thank you, Neil. Cole, please give the directions for the Q&A.

(Operator Instructions) Our first question comes from the line of Samik Chatterjee with JPMorgan.

Satish, can you hear me?

Yes, we can hear you.

Can I start -- if we can start with CISG, where you said demand trends or order trends are stable, maybe if you can sort of dig into that a bit more because there have been concerns given that the smartphone ecosystem still remains really sort of below average in terms of demand that there could be further weakness there? What are you seeing in terms of wireless versus wireline, particularly interested in understanding if you're seeing any demand uplift from the uptakes and the AI applications on the wireline side, just maybe dive into that a bit more, and I have a follow-up.

Sure, Samik. Let me just start by saying the Keysight team executed very well under these conditions, and you see that reflected in the strong quarter and year-to-date performance. Based on our guide, we expect to deliver 7% EPS growth for the year on 1% revenue, and we're maintaining solid profitability. So that's sort of the baseline.

And then when we looked at the orders, obviously, the orders were down 10% year-over-year in Q2, and when you look at our orders right now for the quarter that we reported were down 15%. A big part of that decline year-over-year came from our Greater China operations, which were associated with the slowdown in production, which impacted the EISG business, which was actually holding up pretty well to the first half. And we expect it -- this dynamic to last a few more quarters.

Again, we think it's transient. And I want to stress that based on all of the customer engagements, including the fabs that we engage with, they continue to believe that this is a temporary situation that is playing out.

Now I also want to sort of elevate this to a regional perspective because it will get at the core of your question. Our Americas business grew this quarter on top of a record Q3 a year ago and Europe was stable, driven by strength in EV and AV. And again, I'll go back next to the segment perspective, commercial communications continued to be stable, and I'll get a little bit into the different segments. Aerospace and Defense grew and EISG, as I mentioned before, incrementally declined.

From a commercial communications perspective, 5G investments in R&D continued to be stable. And what was driving some of that is, yes, we still are yet to see any uptick in the manufacturing business associated with the components, and that's correlated with your smartphone declines in the smartphone -- in general smartphone volumes. But I think the driver here is the premiumization of the smartphone market, right?

And that is really resulting in -- those customers that have better-than-expected performance or earnings improvements have actually come back and pulled the trigger on investments with regard to their innovation needs in R&D. And this is, again, reconfirmation of some of our base case thinking that the R&D investments are much more robust and our customers don't want to get behind.

On the wireline side, the dynamics were influenced by AI as a number of hyperscalers starting to look at the AI through the lens of AI, their investments in data center we started to see some uptick in investments in 800 gig. Again, very preliminary, I don't want to draw too far conclusions. One quarter doesn't make a trend. But the stability, 2 quarters in a row, we're quite encouraged by that given the economics. And I also think the breadth of Keysight's portfolio and the contributions we're making end-to-end to the communications ecosystem is enabling us to outperform.

I would say, our network and security business or network and application security business, which was formerly Ixia business, has also been holding up pretty well through the year, and I believe we're continuing to take share. I'll wait for the second part of your question.

For -- relatively sort of, again, thinking in relation to orders and if orders sort of your thoughts on what are -- what we need to see in terms of orders going into next year for Keysight to be able to get back to the long-term growth outlook that you have on the revenue side. Particularly in relation to, I think, historically, your orders and revenues have been pretty tightly correlated. So how are you thinking about what you need in terms of orders?

And maybe one thing to clarify is I didn't really fully comprehend the implication of what Neil is mentioning in terms of more long-term strategic orders from your customers. Is that necessarily a divergence between sort of what you would see on order trends versus that translating into revenue next year? Any thoughts on that, please?

Well, I'll just make some high-level comments. First is the successes we're having in this environment is a function of execution but also a function of the breadth of the company and all the different end markets we serve. Obviously, we don't control the macro, but we're able to figure out where there are strengths, and we're able to maximize such as in aerospace, defense and automotive with AV and EV, which is going through a bit of an uptick in the market, and we're able to capitalize on that and outperform.

I'll just let Neil speak about the guide and the comments you made about our system integration business and associated revenue implications there.

Thanks, Samik. Yes, so as you think about orders, obviously, through the first 3 quarters of this year, we've been able to run revenues at a level that was materially higher than the incoming order rate as we work through some of the backlog that we built up over the COVID period of time and then the supply chain disruptions of the last 12 to 18 months. And as we look forward, we've seen this degradation in the demand environment this quarter that is going to put some pressure on orders as we move into Q4 and likely into Q1. And -- so our ability to continue to drive revenue based on backlog is becoming incrementally challenging, right?

We've burned about $300 million -- burned through about $300 million of backlog so far this year. That's the rate at which revenue has outpaced orders. And then I talked about this change in mix towards longer-dated systems. So there's a small portion of our business, which we haven't talked about much because it's been consistently less than 5%. Where we're working on larger scale strategic programs that are delivered over an extended period of time to our customers. And we view it as very positive that our customers are continuing to invest in those kinds of projects.

That portion of our business was roughly 2% of orders through 3 quarters last year. It's about 8% of orders through 3 quarters this year. And what that essentially means is in addition to the $300 of backlog we've burned, we've taken another $200 million of short-dated backlog and turned it into long-dated backlog. And so as you think about our guidance for Q4, it's essentially built on the scheduled backlog that we have set to deliver into next quarter and our own view of orders for the coming quarter and our ability to turn a portion of those quarters orders into revenue within Q4.

Yes. Samik, I think, just to add to what Neil said, this $200 million that Neil referenced roughly, these are high-quality customers making long-range commitments, further validating our strategy with them. And these are -- you can think of them as large aerospace defense companies that are looking towards -- looking to us to provide more comprehensive solutions and systems.

And in the automotive application, especially with regard to EV and AV, we're offering total solutions, including power management and software for workflow automation and all of those take time for us to complete those projects in tandem with their bring-ups of their Giga factories. So they're highly coordinated, highly strategic to the customers. And I view this as giving us a further penetration with new applications supporting our long-term growth rate.

Our next question is from Mehdi Hosseini with SIG.

This is a follow-up to your commentary to the prior question. I just want to get a better understanding, especially in terms of backlog normalization is good to hear of the strategic orders longer term. And the inherent business is also driven by some of the R&D projects. And in that context, should we assume that backlog normalization is into full gear and then your backlog could remain in a level that would start with a 2 ZIP code and I'm not asking for an order guide, but I just want to better understand how you see the post-COVID normalization of backlog is trending against some of the pluses and minuses in your various parts of the business? And I have a follow-up.

Yes, Mehdi, I think that's largely correct, right? I've talked over the past year about the fact that we felt like we had built 400 million to 500 -- excuse me, $400 million to $500 million of what I call abnormal backlog. And as I just stated, we burnt through $300 million of that through 3 quarters of this year. And then we've essentially converted another $200 million of essentially short-dated turns backlog into backlog for these long-dated programs. So I view that we've materially worked through that abnormal backlog at this point. And I don't think it's unrealistic to assume that in this environment, our kind of normalized backlog level will have a 2-handle on it.

I also think, Mehdi, to the point I think you're alluding to is software and services. We continue to be a stronger -- even in this environment for us, again, reflecting the strength of our customer relationships and so the deferred balance is also a factor that is elevated that leads to the 2 ZIP code calculation you have?

Okay. Great. And my follow-up has to do with the semi mix. I think you mentioned that the semi bookings or new orders were weak in the quarter. Is that due to the delayed ramp of tape-outs for 3-nanometer? And if that's the case, should we assume a rebound in semi-related orders as we start with the new fiscal year, fiscal year '24.

Yes, Mehdi, I think what you've probably seen public announcements from major fabs around pulling back of wafer capacity. So some of the investments associated with our parametric test systems, which typically feed the fabs have been pulled back, especially around legacy technologies and memory applications. So as that rebounds, you can expect that capacity to rebound. Again, this is an area where we have good customer visibility given long-standing relationships that we have had. But it's also a tale of 2 worlds because the same customer base is focused with us relentlessly about the advanced node development, about new application areas such as silicon photonics, which in today's world translates to AI.

And we also have another business that we've talked about in the past around making interferometer systems for 2-nanometers sort of technologies. And there, is no change in demand because we are working with customers on enabling this technology. So yes, there is a pullback in the near term. But again, I want to stress this is temporary and transient.

I just want to understand what increased 3-nanometer tape-out next year have a positive impact for your semi business.

I'll have Mark Wallace take that.

Yes. Mehdi, what I can say is that despite the pullback in the short term, the engagement with our customers on advanced process technologies, including 3-nanometer, 4-nanometer, 2-nanometer have continued. Many of these customers are looking at a variety of aspects of their market as well as managing their financials. A couple of examples, one is, we have a customer in the U.S. that has delayed some of the fab build-out because of construction issues. So we expect that to correct itself in the next couple of quarters.

We have another customer, again, working on these advanced node sizes and technologies who has locations in the U.S. and in Asia, and they're maintaining their total project plan and investment, but spreading the CapEx over several quarters. And there's a lot of those stories. So it really feels to me like we are going through a phase of pullback. But the answer to your question is, yes, we expect this to positively impact our business in 2024.

Our next question is from Aaron Rakers with Wells Fargo.

Neil, I apologize to go back to this, but I want to be clear what I'm hearing from you guys is that it sounds like you believe that backlog coming out of this quarter is basically near normalized levels in your opinion? And I guess what I'm really asking is that if I look back over the past couple of years, appreciating that there's some variables with COVID and everything else involved.

But it looks like seasonally you typically see a sequential increase in your order growth in fiscal 4Q. I guess as I look at that, are you expecting sequential, or how would you characterize seasonal growth in orders or maybe rather discuss it on a book-to-bill basis embedded in your expectation for the fiscal fourth quarter at this point. I apologize for the confusing question, but I'm just trying to understand how you're seeing order growth in backlog.

Yes. No, it's a fair question. So first part, do we believe backlog has normalized. And I'd say the answer to that is largely yes. We believe backlog has normalized at this point. With regard to incoming order rates and seasonality, you're absolutely correct. We typically see a pretty sizable increase as we move from Q3 to Q4 at the end of our fiscal year. And what I would say is we do expect orders to be up sequentially from Q3 to Q4, but we expect significantly smaller sequential increase than would be typical based on weakness of the funnel that materialized during the third quarter.

That's fair. So a book-to-bill improvement from this level is basically what you're alluding to?

Yes. I mean I guess I would think of it as with backlog having normalized, we would expect orders and revenue to start to converge.

Okay. That's helpful. And then I guess as a quick follow-up, I'm just -- maybe the opportunity to ask you about the ESI acquisition. How do we think about that as far as the strategic positioning and what expectations or what kind of targets we should be thinking about as far as that acquisition folding into the financial story as we move forward.

So let me take that. And Neil, if you have anything to add, you could. First of all, I would say it's a great strategic fit, one we're very excited about. I think you've heard me describe the system simulation and emulation opportunity as nearing adjacency to the work that we do with customers, especially as we have focused the strategy on engaging with customers early and in your R&D workflow. So the addition of ESI really is a great fit there.

Financially, it's accretive to our gross margins. It will be when we close the transaction. And we also -- it will be accretive to our software percentage by at least 2 points at the company level. And from a cultural perspective, I think it's very important as well. Here is a company that's been around for 50 years and has been involved in some of the most complex simulations associated with crash testing and other areas, and I think with the -- by coming into Keysight and what's exciting is the combination that can now not only provide go-to-market capabilities that can further accelerate growth, but also engage with customers in new applications in aerospace, defense and other end markets, leveraging the deep technology expertise of ESI. So very excited by this transaction as we announced it.

Our next question is from David Ridley-Lane with Bank of America.

Wondering if the shift to the longer-term orders, is that driven by things that you're doing internally, or is this just a function of the demand that you're seeing from these large aerospace and defense and auto OEMs?

Yes. I think some of it is the implementation of our solutions approach to what was otherwise markets that we had, maybe served purely through the lens of products historically, I think of aerospace defense, David, as an industry where we largely sold instrumentation tools. And over the past few years, we've put focused effort to adding more value to the customer base by integrating the instruments, but also layering on software and creating more services opportunities. So some of it is a function of the go-to-market push that we've had, but also equally the acceleration in demand we see in specific areas such as automotive. And I'll have Mark maybe give you a couple of more examples to make a drill.

Well, it might be just better just to lay it out because it's hard to imagine these, but these are very strategic, very complex engagements with customers. So if we think about an EV or a battery test lab, you're talking about multiple racks of equipment for testing cells and modules and packs. There's battery cyclers. There's low-voltage interfaces for communication. There's a chiller to cool the batteries. Then there's environmental chambers. There's safety aspects, fixturing, software, project management, installation, site prepping very, very complex business.

And then the other thing that's really exciting for us is this gets us deeper into the customers' business. As we announced in Q2, we won 2 new OEM sites in Q2. We won another one in Q3. And over that last 3 months, we have now, through the deeper visibility engagement across the R&D labs have uncovered many other opportunities within those customers and across the ecosystem. So it also has an additive effect in terms of finding new opportunities to contribute. So that's a typical example of why it takes longer.

And then just on the fourth quarter guidance, I think the kind of implied incremental margin is quite high. Is there something unusual about the margins in the fourth quarter this year?

No. I mean I think, obviously, as I've got the Q4 numbers in front of me, we typically see some uptick in OpEx as we move from Q3 to Q4, various factors, but I'd start with the fact that in Q3, a significant portion of the population on summer holidays, spending less money as a result. And as they come back here into the fourth quarter, we tend to see a pickup. We do expect a little bit of a sequential decline in gross margin, a lot of that driven by the implied volume reduction as well as kind of how we're getting to the numbers.

Our next question is from Matthew Niknam with Deutsche Bank.

So, a, I guess I want to just figure out, relative to the order level we're at now, I know it sounds like we're going to get a maybe lower-than-seasonal bump in fiscal 4Q, but it sounded as though this may persist for a couple of quarters, at least based on current visibility. And so what I'm wondering is if we sort of stay at this $1.25 billion, $1.3 billion range, and we work through excess backlog, is it -- and I don't want to jump the gun on fiscal '24, but what I'm effectively getting at is I don't think it's hard to see pathway to maybe more negative or slightly negative growth next year.

So I just want to make sure if that maybe sounds reasonable. And then just maybe, secondly, as we think about the EPS growth outlook, obviously, you're facing a pretty sizable headwind, it seems like from a tax rate. And so I'm curious if there's any color you can add in terms of the margin structure and your ability to maybe effectively flex some of the margin upside that you've showcased in the past around COVID in the times of top line pressure. So full long-winded question, but any color you can provide would be helpful.

Yes. So obviously, we'll give you more color on FY '24 here in 3 months. But obviously, we've spent a fair amount of time thinking through it ourselves. And as you noted, and as I've noted through the first 3 quarters of FY '23, we were able to drive revenue at a level that was significantly above the incoming order rate. As a result, we're going to have some difficult revenue comps as we enter 2024. As I'm thinking about the transition from Q4 into Q1, at least right now, I'm thinking about kind of the typical seasonal decline that we would see on the revenue line as we move from one period to the next. And then I think as we look forward beyond that, right now, we don't see a catalyst right now that is going to drive a significant market recovery in the first half of the year.

But I think we're looking to a recovery in the second half of the year because as Satish has said, we believe that much of what's impacting our markets at this point is temporary in nature, right? Our commercial communications customers are going to work through their inventory challenges. The major investments that we're seeing in fab capacity, they've been delayed, but they're still moving forward, and that includes investments for the insurance of supply for 2 and 3 nanometer, silicon photonics, silicon carbide, all of that stuff is moving forward.

And on the technology side, the R&D investments continue, right? We're going to see additional standards releases for 5G, continued investments in 6G research, AI, quantum, AV, EV, all of that stuff is moving forward. With regard to your EPS outlook, again, tough revenue comps, but we're a disciplined organization with a flexible business model. You've seen that in the results that we published year-to-date, I think, going forward, the challenge for us is to maintain balance, right?

We're optimistic about the long term. We're going to continue with the investments that are going to enable us to fully participate in the recovery when it happens. While at the same time, relying on our discipline to drive EPS growth. We'll certainly work to offset whatever tax impacts we can. But as you noted, the tax impacts are significant.

I will also add that you've seen us -- Matt, you've seen us stay disciplined. And I think at the beginning of the year, I did reference that we would be accelerating some of the synergy work that we were starting to plan for anyway, and we've executed on that very well. And you can see year-to-date, our OpEx has been flat. Even accounting for a lot of the inflation environment. So as we invest in these next-generation technologies that have high customer validation, and we know will position the company to outperform over the medium to long term. We're also remaining prudent and disciplined towards the macro situation in the short term.

Our next question is from Chris Snyder with UBS.

So I very much appreciate that the softer orders and the backlog burn is leading to the softer sequential revenue from Q3 to Q4. But I want to ask about the sequential margins. It seems like the guide puts margins maybe in the mid-28, so down 250-, 300-or-so basis points year-on-year or sequentially. So I'm getting like an 80% sequential decremental, which seems very, very steep. Can you just maybe talk through why that margin fall off is so sharp sequentially?

Yes. I mean I'm not showing it quite as strong on my -- as I'm looking at my pages. You see -- you might want to -- with more time, you might find it's not as steep as you're calculating at the moment. I think I've highlighted the factors we are expecting gross margins to be down sequentially, Q3 to Q4, again, volume dropping a significant portion of that. We did have -- in our Q3 numbers, we did have about $0.03 of kind of onetime effect spread across OpEx and gross margin, mostly related to some favorable onetime impacts with our health care plans that's not expected to repeat. And then again, we're looking at typical sequential increases as OpEx -- in OpEx as we move from Q3 to Q4.

I appreciate that. And then I appreciate the guide on the tax next year from the non-GAAP 15% to 17%. I just wanted to, I guess, maybe a housekeeping one. Is there any change in the cash tax rate when we think about '24 versus '23?

It's a little bit too early to tell. That's why I still have a range. I'll expect to tighten up that range on rate here in 3 months. Outside of even the things that I listed, one of the things that could impact cash taxes is this move towards a corporate (inaudible) tax, which will go into effect for us next fiscal year. So right now, too early to tell. I'll make some comments in the quarter. I'll be better able to address that.

Our next question is from Adam Thalhimer with Thompson Davis.

The revenue guidance for Q4 of minus 10% at the midpoint, do you see both segments down? Can you just help us on how that plays out between the segments?

Yes, just give me 1 second here. Yes, we certainly see -- I mean, we certainly see declines across both segments, which obviously for EISG, which has grown revenues pretty significantly through all -- through the first 3 quarters of the year is a significant change, but we do see revenues down similar levels across both segments.

Okay. Helpful. And then in aerospace and defense, can you talk at all about the outlook there? It's been well-timed acceleration offsetting some weakness in communication. Just wondering if the aerospace and defense can stay as strong?

Yes, I think the -- you look at the security environment around the world, there is no doubt that the defense budgets are getting bipartisan priorities in the U.S. Look at Japan, that's also put out doubling of defense spend in the next 5 years, Europe raising defense spend and security spend as well. So I think this is a business, as we've always said, harder to call on a quarterly basis, but very easy to look at the long-term trend. And our goal is to continue to outperform it. So yes, we expect Q4 to be seasonally strong, generally with the end of the year sort of budgets that come open.

Our next question is from Meta Marshall with Morgan Stanley.

Great. Maybe first question for me. You guys have talked about a lot of new kind of extension areas that you're seeing traction and particularly on the AI side. With the flat OpEx that you've noted, I just wanted to get a sense of how you're making sure to kind of touch base with some of the new customers that might be entering into the space, or how you're finding better leverage through channels. And then as a second question, just as a reminder on the communications group, can you just kind of lay out what you would consider as kind of rough percentages of kind of maintenance standards, so 4G or kind of existing 5G versus kind of the next-gen portfolio.

Yes, I would say we're preserving our R&D investments, so we can outperform the market -- continue to outperform the market as it rebounds in the medium term to long term, which we fully expect it to. With regard to AI, a lot of our customers are launching AI projects in their own way, whether it's in silicon or in the networking side, and so there is a considerable channel leverage there for AI.

Clearly, the move to 800 gig Ethernet that I referenced with higher interface capacity, higher bandwidth, lower power per bit, all of this are -- plays to our strength and our leadership there is helping us pick up some orders and set ourselves up as this business scales that we expect it to.

With regard to the comm segment, in Commercial Communications, 3 dynamics, right? I would say deployments are continuing to scale. Second, globally and as that scales the business there grows. Second one, it's really the standard progression. I would think of Release 17 new use cases are driving customer need. And then the research activities around the world around, call it, beyond 5G because it's too easy to -- too early to call it 6G yet because there's the standard. But beyond 5G, that exploration is proliferating, and I think it fits our strategy to address the R&D customer.

Our next question is from Mark Delaney with Goldman Sachs.

A follow-up question as it relates to 800G Ethernet and some of the AI activity you're seeing. You mentioned some orders already on that front, but you described it as still in the relatively early phases. Do you have a sense of when 800G orders related to AI or other reasons for 800G may become more meaningful?

Yes, I think it's hard to put a timing there, but we've seen this sort of overlapping waves of technology really be the basis of our strategy, Mark. And having that exposure to both wireless and wireline is a core strength for the company, and we're seeing that play out even today, the diversity of applications that we pursue. I would say that the 800 gig Ethernet abilities -- the ability to be first to market, have that capability is definitely helping us now win some early engagements, which should set us up well as that industry scales. As the hyperscalers are coming out of the economic situations in their business, and as they're starting to upgrade, they are looking at 800 gig Ethernet for some of those technical reasons I just mentioned.

That's helpful, Satish. And then on the ESI acquisition, you made some comments already that were helpful, including the gross margin accretion. I apologize if I missed this, but can you talk a little bit more in terms of what it may mean in terms of the EPS contribution when that's integrated, and how you see that progressing over time?

Yes. So obviously -- this is Neil. We do expect that this is -- there's some complexities of doing a public deal in France. It could take us a little bit longer than typical to get the deal fully closed. And for us to then, therefore, begin to start realizing the G&A synergies that we typically rely heavily on to drive EPS. But I think, first and foremost, this is a business that we feel like we can grow pretty aggressively with obviously strong software like margins. We can, via the significant breadth and reach of our sales force, get them access to new market participants and then heavily leverage our G&A, our highly offshore, low-cost G&A infrastructure to drive significant margin expansion for the business and ultimately drive EPS growth.

Our next question is from Rob Mason with Baird.

I wanted to go back to the conversation around these more strategic longer-dated orders. I'm not sure that I still fully understand what the ship schedule or revenue recognition timing would look like on those? And I'm just curious as well as those have been booked into orders. Did -- have you widened or changed the order booking policy around kind of shippable in the next 6 months around those time.

Yes. I would say, again, this is a very small part of our business historically. So we've never had to speak about it. As a function of the lower order levels today as a percentage appears higher. But -- so no change to our order acceptance policy other than these are complex systems, which require us to start work today, buy inventory and staff people to deliver to our customers. So they are on the books for the right reasons. They are high-quality deals that we feel good about...

Generally un-cancelable without significant penalty would be the last part of that, I would make. And from a delivery schedule, you could think of them, certainly beyond 6 months, or they'd be within the standard, but you can think of it as in the case of a lot of the aerospace, defense kind of 12 months, some of the auto ones are 18 months or more because they tend to be even longer types of programs for us to deliver. So as we mentioned in the prepared comments, some of these deals are scheduled for revenue recognition out in 2025, upon delivery of the complete project to the customer.

Understood. Understood. And just as a follow-up, Satish, the -- certainly, ESI Group, it certainly makes sense from the standpoint of moving upstream and staying very close to R&D and into simulation. But I'm just curious, how do you think about the opportunity set beyond kind of core electrical engineering customer base. This is around more physical test. Do you start to -- was ESI unique in that regard, or do you start to look more broadly at things outside of electrical engineering test?

Yes. Definitely. The -- when we look at the entire system simulation, emulation opportunities, what you really need is the ability to simulate very complex interactions of physical, electrical and software capabilities. So again, plays to the system strength that the company has. So having these assets in the company will allow us to identify new use cases and serve them differentially, which I think puts us in a very unique spot given our entire portfolio and test now mirror it with a strengthening portfolio in design.

I think we see this as a very unique positioning for the company, one that aligns with our software-centric transformation that we've been on. I also think that being a European asset, obviously, a French asset that's been in France, there is more opportunity with our U.S. base of customers to really focus this go-to-market motion and accelerate growth and create greater value.

I would just add one thing to the exciting part is the alignment to the verticals, automotive, aerospace, defense, it's broadening our footprint and broadening our value to these important customers.

Our next question is from Atif Malik with Citi Research.

It's Adrienne Colby for Atif Malik. I wanted to ask a clarifying question on orders. You had commented that the 15% decline in overall orders was heavily influenced by China. Just hoping you could clarify what you saw in the Americas and Europe if you were seeing improvements in the rate of year-over-year declines there.

Yes. I think I mentioned, Adrienne, good question, our Americas business grew quarter-over in Q3 and Europe was stable.

And sorry, was that sequentially or year-over-year?

Year-over-year.

And then I just wanted to ask with regards to the long-term strategic multiyear engagements you've been speaking about. Can you comment on how much of the growth in orders is a factor of upselling or expanding some of the existing agreements versus new agreements? Just trying to get a sense of the number of customers that are falling into this category if that's growing.

Yes, Adrienne, I think it's a combination. As I mentioned before, these strategic first-time wins with the automotive OEMs into themselves are long-dated and large. And through the process, we work with the customers to upsell and cross-sell capabilities and then get more visibility across other parts of the groups as they're oftentimes organized across the ecosystem as well.

So I think the way to think about it in simplest terms is these longer-term programs are about as strategic as we can get with our customers. So it opens up new opportunities to sell including software and other aspects of delivering value, services, et cetera. So we're excited about it, and we're looking forward to continuing to deliver through these vehicles.

Thank you. That concludes our question-and-answer session for today. I would like to turn the call back to Jason Kary for any closing comments.

Thanks, Cole, and thanks, everyone, for joining us. I'm going to turn it over to Satish for a few closing comments, and then we'll wrap up the call.

Yes. Thank you very much. I know we discussed quite a bit today, but I want to leave you with some few important takeaways. First, we're executing very well, maximizing our performance in the near term, and we're tracking to deliver 7% EPS growth with 1% revenue growth this year solid profitability in the business, and you should take that away.

Second, we have strong differentiated portfolio that's aligned with multiple end markets and customer priorities, and this will continue to enable us to outperform both in the near term and will go stronger as market conditions change. You see the differentiation in our portfolio reflected in our ability to maintain strong gross margins in our business in these conditions.

Third, we have a strong balance sheet, strong cash position, and we remain confident in our free cash flow generation capabilities in the business, and we will continue to maintain the balanced capital allocation approach that we described at Investor Day.

Fourth, we have a proven operating model with a highly flexible cost structure and which has been proven before and will continue to play out as we had projected as well.

Fifth, we have a seasoned management team here that has experience in the business for decades, and we'll continue to remain proactive and balanced in navigating this environment, and you've seen us do this already this year.

Finally, I would want to remind everyone that we remain incredibly confident and excited about the favorable long-term secular trends that are underpinning of our growth strategy. This is around the next-generation technology waves, new addressable customers and industries and R&D investment wave across multiple end markets. We are focused on positioning the company to grow and emerge from this environment stronger.

Thank you very much for joining us today. I'll hand this back to Jason.

Thank you, Satish, and that concludes our comments today. Have a great day.

That concludes today's conference call. You may now disconnect your lines.