Keysight Technologies Q4 2022 Earnings Call Transcript

Participants

Corporate Executives

• Jason Kary, Vice President, Treasurer & Investor Relations
• Satish Dhanasekaran, President and Chief Executive Officer
• Neil Dougherty, Executive Vice President and Chief Financial Officer
• Mark Wallace, SVP, Global Sales & Chief Customer Officer

Analysts

• Angela Jin, JPMorgan Chase & Co.
• Chris Snyder, UBS Group AG
• Mehdi Hosseini, Susquehanna Bancshares, Inc.
• Matthew Niknam, Deutsche Bank Aktiengesellschaft
• Aaron Rakers, Wells Fargo & Company
• Jim Suva, Smith Barney Citigroup
• Meta Marshall, Morgan Stanley
• David Ridley-Lane, Bank of America Merrill Lynch
• Rob Mason, Robert W. Baird

Presentation

[Operator]

Good day, ladies and gentlemen, and welcome to the Keysight Technologies Fiscal Fourth Quarter 2022 Earnings Conference Call. My name is John Payne, I will be your lead operator today. [Operator Instructions] This call is being recorded today, Thursday, November 17, 2022 at 2:00 PM Pacific Time.

I would now like to hand the conference over to Jason Kary, Vice President, Treasurer and Investor Relations. Please go ahead, Mr. Kary.

[Jason Kary, Vice President, Treasurer & Investor Relations at Keysight Technologies]

Thank you, and welcome everyone to Keysight's fourth quarter earnings conference call for fiscal year 2022. 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.

You can find the press release and information to supplement today's discussion on our website at investor.keysight.com under the Financial Information tab and Quarterly Reports. Today's comments by Satish and Neil will refer to non-GAAP financial measures. We will also make reference to core growth, which excludes the impact of currency movements 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 Credit Suisse and Wells Fargo. We hope to see many of you there.

And now, I will turn the call over to Satish.

[Satish Dhanasekaran, President and Chief Executive Officer at Keysight Technologies]

Thank you, Jason, and thank you all for joining us. Keysight reported strong fourth quarter results, which exceeded the high-end of our guidance and drove a strong finish to the year. Before we get into the quarter, I want to highlight our exceptional performance for fiscal year, which illustrates continued progress we're making in transforming the company to a software-centric solutions provider. We set new records for orders, which grew 12% to $6 billion, a new record for revenue, which was up 10%, and a new record for earnings per share, which increased 22%, all the while returning capital through $849 million in share repurchases or 89% of free cash flow. In addition, we continue to invest in next-generation technologies for long-term differentiation and see a high-level of engagement and activity with our customers around their future needs.

Today, I'll focus my comments on three key headlines. First, we delivered an all-time record revenue and earnings per share in the fourth quarter ahead of expectations enabled by outstanding execution by Keysight teams who successfully navigated supply chain geopolitical and macro-dynamics. Second, we achieved record orders of $1.6 billion, with steady bookings throughout the quarter and the book-to-bill of 1.09. While our customers multi-year roadmaps remain unchanged, they are exercising more caution given the macro backdrop, which we anticipate will moderate demand in the near-term. Third, as we enter fiscal '23, we remain confident in our ability to outperform the market based on the differentiation of our solutions, our strong R&D customer value proposition and the robust backlog position we have entering the year, and as we look longer-term, the secular innovation trends in our end-markets remained strong.

Now, let's take a deeper look at the strength of the fourth quarter. Record orders of $1.6 billion, grew 9% on a core basis. Record revenue grew 15% on a core basis, with solid growth across all regions, as Keysight team successfully navigated challenging dynamics. This resulted in record quarterly earnings of $2.14 per share. The strength and resiliency of our business model is due to our strategic efforts to diversify our industry exposure. This has been best exemplified in the growth of our Electronic Industrial Solutions Group and our ability to leverage our industry-leading first-to-market solutions to enable expansion across the broader communications ecosystem. EISG achieved its ninth consecutive quarter of double-digit order and revenue growth.

Auto, semiconductor solutions and general electronics, all achieved record quarterly revenue. For the year, both orders and revenues set new records as we capitalized on continued investments across all three EISG markets. In automotive, we're pleased with the continued adoption of our solutions portfolio as orders grew double-digits for the seventh consecutive quarter and exceeded $500 million this year. Automotive OEMs and their suppliers continued to focus on strategic new mobility investments, which drove key wins for Keysight. In addition automotive-focused semiconductor companies continued to add capabilities to support EV and AV applications, which we view as a favorable long-term dynamic.

We recently announced the Scienlab DC Emulator, which enables customers to accurately characterize high voltage high-power electric vehicle battery performance under varying real-world charging conditions. And Keysight's PathWave Labs Operation software won 2022 AutoTech Breakthrough Award for Overall Electric Vehicle Technology. In support of AV applications, silicon designers are exploring adoption of commercial standards such as MIPI for automotive and other surround sensor applications, including cameras and in-vehicle infotainment displays. We are now expanding our leading compliance test solutions to offer advanced verification and diagnostic capabilities for automotive designers.

Turning to our semiconductor solutions business, Q4 was the 10th consecutive quarter of double-digit order growth and a record revenue quarter. We saw sustained demand for our wafer test solutions and precision positioning capabilities, which enable the realization of advanced process nodes. In addition, Keysight has continued to partner with industry leaders, Synopsys and ANSYS on RF and millimeter-wave integrated circuit design flows, built for today's wireless communication requirements, including 5G and 6G system-on-chips. Keysight received a Partner of the Year Award from TSMC for joint development design flows in RF and millimeter-wave nodes. In general electronics record orders grew double-digits this quarter as demand remains strong and broad-based across industrial IoT and digital health as well as education and advanced research markets.

Turning to Communications Solutions Group, the business delivered strong orders and record revenue. Annual orders and revenue were all-time highs despite geopolitical headwinds and delays in US defense budget appropriations. Commercial Communications revenue grew 10% this quarter and 11% for the year with growth across all regions. Investments across communications ecosystem continued throughout the year with sustained spending in next-generation wireless and wireline technologies. Ongoing investments in 5G standards, new spectrum, growing deployments around the world and steady evolution from 400 gig to 800 gig to terabit Ethernet drove growth.

We had another record year for 5G orders, as Keysight's market-leading solutions continue to provide the industry with new capabilities needed for development of next-generation devices, as well as wireless and wireline networks. Examples that highlight our portfolio's alignment with key industry priority include a recent partnership with IBM to integrate our Open RAN capabilities into their cloud automation tools to accelerate network deployments. We also completed the validation of our first 5G location-based service use-case from Global Certification Forum, by combining the testing of 5G new radio and Global Navigation Satellite System technologies into a single platform.

Lastly, in collaboration with key silicon and data center partners, we enabled the industry's first 1.6 terabit transmission and data center interconnect, leveraging our high-speed digital solutions. Aerospace, defense and government business revenue grew 4% for the quarter and 3% for the year, setting a new record while navigating geopolitical headwinds. Steady investments in spectrum operations, cyber security and space and satellite drove demand. 5G continued to expand in aerospace and defense end-markets and we saw increasing investment in advanced research. Proposed increases in investment in the US and allied countries for modernization of defense capabilities, a new satellite and space applications, position us well for future opportunities.

As an integral part of our solution strategy, software and services order and revenue growth this year continued to outpace Keysight overall, which has driven our annual recurring revenue to approximately $1.2 billion. Software and services again represented just over one-third of Keysight's total revenue for the year. Keysight's focus on customer success and innovation is driving our development of first-to-market high-value solutions. Our achievements over the years exemplify Keysight's collaborative culture and our talented workforce and we are honored that Keysight has placed 10th on the Fortune's Best Workplaces in Technology List for 2022. We believe our differentiated culture gives us a unique ability to recruit and develop capable talent and will be our sustaining competitive advantage.

In conclusion, I would like to thank our employees for all their contributions, commitment and strong track record of execution. In the midst of an uncertain economic environment, we remain confident in the resilience of our business, the strength of our balance sheet and the flexibility of our operating model.

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

[Neil Dougherty, Executive Vice President and Chief Financial Officer at Keysight Technologies]

Thank you, Satish and hello, everyone. We delivered an outstanding fourth quarter of 2022 with record revenue of $1,443 million, which was above the high-end of our guidance range and grew 11% or 15% on a core basis. Our strategies to navigate the ongoing supply constraints continue to be effective. While the supply chain situation improved within the quarter, it continues to moderate our near-term revenue expectations. Record orders of $1,570 million, increased 5% or 9% on a core basis and we entered fiscal year 2023 with over $2.5 billion in backlog.

Looking at our operational results for Q4, we reported gross margin of 64%, which as expected, was down 80 basis points sequentially due to inflationary pressures and increased shipments of lower-end instruments enabled by the improving supply chain. Operating expenses of $494 million were well-managed and we generated operating margin of 30%. Net income was a record $386 million and we achieved $2.14 in earnings per share, which was $0.14 above the high-end of our guidance. Our weighted average share count for the quarter was 180 million shares. Foreign exchange impact on our earnings was negligible, thanks to a meaningful natural hedge provided by our global footprint, which was then supplemented by our financial hedging program.

Moving to the performance of our segments, the Communications Solutions Group achieved record revenue of $992 million, up 8% or 11% on a core basis. CSG delivered gross margin of 66% and operating margin of 29%. Commercial Communications generated revenue of $681 million in the fourth quarter, up 10%, driven by strength across the 5G ecosystem, increasing O-RAN adoption and investment in 800 gigabit and 1.6 terabit R&D. Aerospace, defense and government achieved record revenue of $311 million, up 4%, driven by double-digit growth in Asia-Pacific and Europe. The Electronic Industrial Solutions Group achieved record revenue of $451 million, up 20% or 25% on a core basis, driven by strength across all markets. EISG reported gross margin of 60% and operating margin of 32%.

Turning to our full year financial performance, Keysight delivered outstanding results in 2022, despite ongoing supply constraints, foreign exchange headwinds and incremental trade restrictions. FY '22 revenue totaled $5.4 billion, up 10% year-over-year or 12% on a core basis. Gross margin was flat at 65%, holding steady in the face of significant inflation. We invested $813 million in R&D, while operating margin improved 140 basis points to 29%. FY '22 non-GAAP net income was $1.4 billion or $7.63 per share, up 22%.

Moving to the balance sheet and cash flow. We ended our fourth quarter with more than $2 billion in cash and cash equivalents, generating cash flow from operations of $398 million and free cash flow of $340 million. Total free cash flow for the year was $959 million, representing 18% of revenue and 69% of non-GAAP net income. Share repurchases this quarter totaled approximately 800,000 shares at an average price per share of $158.77 for a total consideration of $126 million. This brings our total share repurchases for the year to approximately 5.4 million shares at an average share price of $156.09 for a total consideration of $849 million or 89% of free cash flow.

Now, turning to our outlook and guidance. We exit the year with record backlog and confidence in Keysight's ability to continue executing through near-term uncertainties. As a result, we expect first quarter 2023 revenue to be in the range of $1.360 billion to $1.380 billion and Q1 earnings per share to be in the range of $1.81 to $1.87 based on a weighted diluted share count of approximately 180 million shares.

A few modeling reminders as we enter the year. Our annual compensation cycle is administered in Q1 and in this current inflationary environment, we expect our second consecutive year of wage increases above our historic average. We are targeting FY '23 R&D investment at approximately 16% of revenue, annual interest expense is expected to be approximately $80 million, capital expenditures are expected to be approximately $250 million and we are modeling a 12% non-GAAP effective tax rate for FY '23.

In closing, we recognize the uncertainty of the current macro-environment and will continue to be disciplined. Keysight's highly flexible cost structure, track-record of execution, diverse end-markets and long-term secular growth drivers, give us confidence in our ability to outperform the market.

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

[Jason Kary, Vice President, Treasurer & Investor Relations at Keysight Technologies]

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

Questions and Answers

[Operator]

Of course. [Operator Instructions] Our first question comes from the line of Samik Chatterjee. Your line is now open.

[Angela Jin, Analyst at JPMorgan Chase & Co.]

This is Angela Jin on for Samik Chatterjee. Congrats on the strong quarter and outlook. My first question is sort of related to what you mentioned briefly in the prepared remarks on a macro slowdown and perhaps some pullbacks. I'd like to dig in a little more there given that we've seen commentary from other companies indicating that there is a pullback in telco capex. Are you seeing any impact to our R&D budget? And I have a follow up. Thank you.

[Satish Dhanasekaran, President and Chief Executive Officer at Keysight Technologies]

Thank you, Angela. Yes, we're very pleased with the quarter and in consideration of this environment pretty strong results and also a strong finish to the year. And as I stated we saw a steady level of spend from a demand perspective through the quarter. All our regions from a sales perspective grew. So, it was broad-based. And going into a little bit on the end-market color I would say 5G continues to remain strong. We grew our 5G orders double-digit, strength in R&D and also with the inflections that we're seeing in deployments around some parts of the world, even some of the manufacturing spend there remained strong for us this quarter. And we did see pockets of weakness in the broad component ecosystem and that was an area we obviously watch carefully and that is related to the smartphone demand. And if you look at the cloud and data center markets in wireline, while some of the cloud, direct cloud spend from the cloud providers was pushed out, service providers was pushed out, the broad spend to adopt 400 gig and 800 gig continues to remain strong. So, they focus on R&D and new innovations remain strong.

Moving on to aerospace and defense business, obviously, it was still a strong quarter for us but we did not see the typical year-end surge that we would expect given the budget appropriations process. And then moving to EISG end-markets, all of the markets remained strong, right. Automotive, we had strong double-digit growth, as continued investments and inflection from EV and AV are playing out. Semiconductor is an area we watch carefully, but because of our exposure into the wafer stage equipment process and specifically new nodes that remained strong. And lastly, the general electronics business, which typically gets its part of it spend from PMI continued to remain strong from a demand perspective. So, I would say we're doing well and the customer activity with our customers and engagement remained strong and quite pleased with our quarter in this environment.

[Angela Jin, Analyst at JPMorgan Chase & Co.]

Great. Thank you so much for that color and then just for my follow up. You posted 10% revenue growth this year and I know your long-term guide, sort of mid-single-digit revenue growth. Just what are you thinking sort of broad strokes for fiscal '23 revenue growth? Did you see any pull-forward with supply easing and so could there be an air pocket in fiscal '23 or do you still expect to sort of perhaps trying to bob your typical long-term range? Thank you.

[Satish Dhanasekaran, President and Chief Executive Officer at Keysight Technologies]

Yeah, we remain confident Angela with what we see so far. Obviously, it's an uncertain environment, so we're guiding one quarter at a time. You see the confidence reflected in our Q1 guide, which is, which we feel good about. And as we look forward, we'll look at the demand environment and we'll keep you updated as we go.

[Operator]

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

[Chris Snyder, Analyst at UBS Group]

Thank you. I wanted to follow-up on those comments on the market demand commentary. I mean orders were I think you said steady each month of the quarter and up 9% year-on year. So, what should we make of the commentary that maybe customers are being a bit more cautious because, Satish as you just kind of ramped through all the different sub-segments and businesses, it seems like everything is going quite strong. And if we take this is a maybe an indicator that fiscal Q1 orders are easing a bit and ultimately does this push that, the growth profile back to that 4% to 6% normalized range? Or could it sink below that? Thank you.

[Mark Wallace, SVP, Global Sales & Chief Customer Officer at Keysight Technologies]

Hi, Chris, this is Mark, I'll take that and add a little bit more detail here. So, Satish said our order level was steady throughout the quarter, so we're watching. That's right because if customers are taking more time to make decisions, you would look for orders to slow down, they did not. As a matter of fact, October was very strong. It was a record October for us in terms of orders, so that's good. You've heard us talk about before the addition of new customers. We've added about 450 this quarter again for nearly 2,000 new customers across the whole year, so that creates that creates more diversity and durability to our business and I see that paying-off. Our top 20 customers in the quarter were up strong double-digits as well.

So, all of that continues to translate to the fact that we did not see an impact to our business because of the customer is taking more time. And I think it also has to do with the fact that we are so biased toward R&D and design optimization. And as we've seen through other waves in the recent term where some market slowed, the advanced technology development continues. So, that's what we see, but we look around and we do see some macro uncertainty. And from my seat, what I see in terms of order or in terms of customer activities is very active customers, our six-month funnel continues to grow but customers are taking more time to make ultimate capex decisions.

[Neil Dougherty, Executive Vice President and Chief Financial Officer at Keysight Technologies]

Yeah, and this is Neil. I'd just give you a little bit maybe more a quantification of the situation going into Q1. So, while we don't guide orders, I would point out that we have a bit of a difficult compare here in the first quarter. A year ago in Q1 that was the first time in Keysight's history that we'd ever posted order growth moving from the end of Q4 into the first quarter of the new fiscal year. So, we've got a tough compare from that perspective. In addition, as you all know, the US dollar began to strength pretty significantly in the back half of this year, we estimate that the FX headwind in our first quarter to be a full 5 percentage points and so we've got a 5 point FX headwind. And we estimate another 2 points to 3 points of headwind from the recent increase in China trade restrictions as well as the loss of our Russia business, which happened in the second quarter of last year. So, those things combined give us a 7 point to 8 point headwind just coming out-of-the gate here as we enter the first quarter.

[Chris Snyder, Analyst at UBS Group]

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

[Satish Dhanasekaran, President and Chief Executive Officer at Keysight Technologies]

Yeah, Chris, I think you're right. I think as as the supply chain continues to ease and the delivery duration that it takes for us to fulfill an order continues to pull in, you would expect some level of normalization as well. And the reason we also put out that the demand environment is moderating is, we are starting to also see some of our customers whose earnings has fallen also put additional scrutiny on spend, right. And so that takes a little bit more time to close the deal as they go through their process. So, those are some factors.

Neil, I don't know if you want to, I know you've commented on the normalization before.

[Neil Dougherty, Executive Vice President and Chief Financial Officer at Keysight Technologies]

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

[Chris Snyder, Analyst at UBS Group]

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

[Satish Dhanasekaran, President and Chief Executive Officer at Keysight Technologies]

Thank you, Chris.

[Operator]

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

[Mehdi Hosseini, Analyst at Susquehanna Bancshares]

Yes, thanks for taking my question. Two follow-ups. I wanted to go back to capex, the $250 million. Should I assume the capital intensity will remain around 3% in fiscal year '23?

[Neil Dougherty, Executive Vice President and Chief Financial Officer at Keysight Technologies]

Yeah, so I mean one of the things that's happening with our capex is our capital purchases in this fiscal year were definitely impacted by the broader supply chain environment. And so we guided at the beginning of the year, I'm talking about fiscal '22 now to capex that was close to $250 million and we significantly underspent that from a cash flow perspective. But what you can't see is that our commits were very much in line with our original expectations. It just took longer for things to be delivered. And so what we're seeing as we go into next year is a pretty dramatic scaling back of new capital purchases, but with a little bit of a cash flow overhang as we go into next year. And so that's what's going to carry our capital purchases up to that $250 million level in fiscal '23.

[Mehdi Hosseini, Analyst at Susquehanna Bancshares]

So, I shouldn't use that your capex guide to come up with some the revenue guide or revenue growth expectation for fiscal '23? There is some cash flow as we have the capex, right?

[Neil Dougherty, Executive Vice President and Chief Financial Officer at Keysight Technologies]

That's, right.

[Mehdi Hosseini, Analyst at Susquehanna Bancshares]

Okay. And then I want to go back to China, the APAC region as a percentage of revenue has remained in the low 40% over the past several years, including the headwind from Huawei. Should I assume that you are growing outside of China, so much should extend that you're able to offset increased restriction on shipment to China? Is it just the mix within the APAC region that makes China kind of neutralize?

[Satish Dhanasekaran, President and Chief Executive Officer at Keysight Technologies]

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

[Mehdi Hosseini, Analyst at Susquehanna Bancshares]

Okay. So, the fact that the supply chain is moving out to the China, that's positive. Now, if I may just quick follow-up. So, you do have more than 50% exposure to your customers' R&D budget. On top of that there is a structural changes happening with the supply chain that is also positive and those two factors on aggregate could offset some of the cyclicality in nature or production-related sensitivity or volatility. Is that the right way to think about this?

[Satish Dhanasekaran, President and Chief Executive Officer at Keysight Technologies]

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

[Mehdi Hosseini, Analyst at Susquehanna Bancshares]

Thank you.

[Satish Dhanasekaran, President and Chief Executive Officer at Keysight Technologies]

Thank you.

[Operator]

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

[Matthew Niknam, Analyst at Deutsche Bank Aktiengesellschaft]

Hey, guys, thank you for taking the question. Two, if I could. First, on backlog, so you mentioned you ended the year at about $2.55 billion. I think our math would suggest something about $100 million higher just relative to the $2.5 billion you mentioned last quarter. I'm just wondering if there's any order cancellations to be aware of or if there's an FX component affecting this?

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

[Neil Dougherty, Executive Vice President and Chief Financial Officer at Keysight Technologies]

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

[Mark Wallace, SVP, Global Sales & Chief Customer Officer at Keysight Technologies]

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

[Matthew Niknam, Analyst at Deutsche Bank Aktiengesellschaft]

Got it, thank you.

[Mark Wallace, SVP, Global Sales & Chief Customer Officer at Keysight Technologies]

You're welcome.

[Operator]

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

[Aaron Rakers, Analyst at Wells Fargo & Company]

Yeah, thanks for taking the question and congrats on a good execution in the quarter. I just want to add a high-level go back to kind of the defensibility of the model if I can. Can you remind us where the mix of the business stands today between R&D exposed versus, let's say, manufacturing exposed? And I guess on that same kind of thought processes is that where do you stand as far as the monetization effect of the software strategy? Where do we think that progresses to over the next year or whatever time frame you want to think about?

[Satish Dhanasekaran, President and Chief Executive Officer at Keysight Technologies]

Yeah, thank you for the question. I think at the highest level we're at approximately 60% R&D today, 30% manufacturing and 10% deployments, so that's the sort of mix of the business. Clearly, we believe R&D is secular. You look at some of the areas in R&D that we're focused on that involved next-generation innovations such as with 5G and then 6G and automotive and digital health, so on and so forth and it really gives us this diversity of applications that is, gives us a resilience in this environment for sure.

With regard to the software strategy, it again, goes congruent with our go-to-market approach because we're here to enable innovations to happen faster and the way we do that is by offering more software-centric solutions. So, as we deploy more solutions to our customers increasingly that is in the form of growing software mix and that goes again synergistic with our services strategy. So, you look at our software and services revenue this year, we'll end at 34% after total mix and ARR or annual recurring revenue has reached a new high of $1.2 billion and will continue to invest to grow those portions of the business and increase our resilience and durability over-time as well. Thank you.

[Aaron Rakers, Analyst at Wells Fargo & Company]

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

[Neil Dougherty, Executive Vice President and Chief Financial Officer at Keysight Technologies]

Yeah. I mean given some of the dynamics that Satish just talked about increasing software services, recurring revenue, we have seen growth in our deferred revenue over the same 3-year period of time as well as our migration towards systems rather than tools, I think will drive our ultimate backlog level when things normalize to be significantly higher than it was say, pre-COVID in the 2018-2019 timeframe. And so I think we'll have to see how that plays out over time.

I think again, we've built -- you can do the math, we built well north of $1 billion of backlog over the course of the last three years as we've had this book-to-bill that I had mentioned at 1.09 and as our lead times come in, we're going to expect ordering patterns to adjust and your lead times to pull-in. I've said previously that there is probably four to five weeks worth of kind of abnormal backlog as a result of four to five week extension of lead times, kind of on average should be a way to think about it.

[Satish Dhanasekaran, President and Chief Executive Officer at Keysight Technologies]

We're still in a supply challenged environment. While it's improving, supply is the constraining factor right now.

[Aaron Rakers, Analyst at Wells Fargo & Company]

Thank you.

[Operator]

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

[Jim Suva, Analyst at Smith Barney Citigroup]

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

[Satish Dhanasekaran, President and Chief Executive Officer at Keysight Technologies]

Yeah, Jim. I think as a strategy, as a company from 2015 we've been focused on the software-centric solution strategy and really focused on our customers' most demanding and challenging problems that they have and solving this better than anyone else. And as we have continued to do that our strategy has taken the form of not just a per incident sale but our focus on this lifecycle value creation for our customers but also value capture for Keysight and that's the journey we've been on.

Some of the more newer solutions such as in Open RAN that we've talked about where we are seeing considerable traction, software alone is nearing 40%, 50% of the total sale value and with a lot bigger portion of it being in the recurring category as well. So, we feel good about the continued traction we're seeing for our solutions as we continue to deploy the solution strategy over time, we will enter into new end-market verticals. And as you've seen some examples that put out this this latest earnings announcement, we've also had some successes in the automotive sector with deploying software and in the semiconductor as well with our design offerings.

Mark may make some comments on the sales side.

[Mark Wallace, SVP, Global Sales & Chief Customer Officer at Keysight Technologies]

Yeah, thanks Satish. And Jim, what I would ask is the go-to-market you mentioned that and that is an important element of this. We are attaching upfront attach services and software. We're at about 60% for services today, I want to see that grow, so that's another stream of advancement. The other thing that you can see is we are delivering solutions more and more through updates to our software. If you think about our 5G solutions going from Release 15 to Release 16 and 17, much of that is software updates that creates additional opportunities for upsell, cross-sell and of course recurring revenue as well. So, there's several elements of our go-to-market that we are deploying now to encourage that recurring growth and expansion of attachment upfront to our total solutions.

[Jim Suva, Analyst at Smith Barney Citigroup]

Great. And then my follow-up is on the China, I think I heard 2 points to 3 points of headwind, is that for kind of the full fiscal year. Was there any like in calendar, I'm sorry, fiscal Q4, like buying ahead of the rule changes. I am just trying to triangulate around the magnitude of it and I assume after fiscal '23, it's kind of all out of the model from the rule changes.

[Mark Wallace, SVP, Global Sales & Chief Customer Officer at Keysight Technologies]

Yeah, Jim, I think we said 1 points to 2 points of headwind for the entire fiscal year '23. And again, that's based on what we estimate as the run-rate of business that won't be available to us with the new trade restrictions. There will be a little bit more in Q1 as we look at some of the backlog but that's the run rate and then there was another I think Neil mentioned another point headwind with -- from Russia.

[Jim Suva, Analyst at Smith Barney Citigroup]

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

[Satish Dhanasekaran, President and Chief Executive Officer at Keysight Technologies]

Thank you, Jim.

[Operator]

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

[Meta Marshall, Analyst at Morgan Stanley]

Great, thanks. In the past you guys have talked about kind of that the 5G peak was going to be much later than kind of investors were expecting, but you kind of talked about a '23-'24 time period for the 5G peak. I just wanted to kind of get current thoughts on that. Just how initiatives like O-RAN or just some of the other initiatives are maybe extending that?

And then maybe second, you gave some context that you're seeing some loosening of supply chain but just kind of what is current thinking? Is it still just a small amount of parts that you're kind of waiting to release? Just when do you see more general availability of those parts and just kind of a tightening between supply and demand? Thanks.

[Satish Dhanasekaran, President and Chief Executive Officer at Keysight Technologies]

Yeah, thank you, Meta. I think on the 5G front, I think as we've always stated there's multiple catalysts. I think about 18 months ago, I said the first catalyst was the C-band deployments in the US, that's played out as we had hoped and we have captured a lot of that spend. We are pleased with some action that's happening in Asia and India, parts of India that have made commitments to rollout 5G. So, that's again opportunity for us that's playing out right now. But the second and the third parts to this is the millimeter-wave opportunity.

There is still some complex challenges with millimeter-wave that customers are trying to solve. That continues to be longer-term R&D opportunity for us as that deployment is continuing to push-out anyway scale deployments anyway. And lastly, as 5G is deployed, operators are looking to further monetize by adding the SA versions and new applications such as Open RAN continue to be -- gain traction across the global ecosystem. And so the opportunity that we have in R&D continues to grow and we're well-positioned with a comprehensive offerings we have to address it.

I also want to point out that we have a very diversified business. Yes, 5G gets a lot of attention, but we have secular trends in wireline evolutions which we are well-positioned to capitalize on based on the acquisitions of Ixia that we have made and we continue to see traction there. Not to mention the newer additions to our go-to-market with automotive and with next-generation semiconductor node. So, we run a diversified business and I think that's -- that source of greater stability for us and overtime.

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

[Meta Marshall, Analyst at Morgan Stanley]

Great, thank you.

[Operator]

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

[David Ridley-Lane, Analyst at Bank of America Merrill Lynch]

Sure, good evening. You talked about some of the headwinds to revenue in the first quarter, but one tailwind not mentioned is pricing and I just sort of wondering how significant is pricing today versus more normal levels? And you are getting a couple of points tailwind from that. And then what type of volume growth is really embedded into first quarter's guidance?

[Neil Dougherty, Executive Vice President and Chief Financial Officer at Keysight Technologies]

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

[David Ridley-Lane, Analyst at Bank of America Merrill Lynch]

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

[Neil Dougherty, Executive Vice President and Chief Financial Officer at Keysight Technologies]

Yes. I'm going to take the pricing question, obviously we've been doing our best to keep place with inflation, we've had multiple rounds of price increases over the course of the last 12 to 18 months and those are embedded in the backlog, although I think you can see based on the fact that we have maintained margins over the course of fiscal '22 at flat at 65% which, frankly, I think in this inflationary environment was a very strong result that we're basically keeping pace on a margin basis with what we're seeing in terms of increases.

And so right now while on the one side, yeah we have these price increases that are embedded in our backlog and will continue to yield dividends and revenue, it's not like the inflationary elements have stopped and the cost structure as well. I referenced for example, that we are going to be doing our salary administration for next for next year here in our fiscal first quarter and this will be our second consecutive year with salary increases that are materially above our historic averages. As to the volume question, given the nature of our business where we're selling instruments that literally cost in some cases hundreds of dollars, in other cases cost million-dollars, that's a very difficult question to answer. There is such a high deviation of mix that it's really hard to get to a meaningful answer on that question.

[David Ridley-Lane, Analyst at Bank of America Merrill Lynch]

And as a follow-up, another tailwind here is autos, right. I think last quarter you mentioned that it's basically doubled over the last two years. This quarter you mentioned $500 million in orders, so it's nearing close to 10% of your orders in this fiscal year. Do you feel like the trend there is kind of, I don't want to say not subject to the sort of macroeconomic conditions but certainly has a strong secular element to it.

[Mark Wallace, SVP, Global Sales & Chief Customer Officer at Keysight Technologies]

David, this is Mark, I'll answer that. The growth we're seeing is coming from next-generation mobility. There's some continuing R&D on the electronics side that's more conventional but the growth in new mobility is sustaining, it is secular and it doesn't just stop at the vehicle, it goes out into the charging infrastructure, into the underlying battery technologies and we've seen what's happened here in the last year with different countries and different regulations pushing this further toward adoption. The adoption in Europe is very, very strong and growing fast, in other regions as well.

And our position in the market is very strong helping our customers design and deploy this next-generation technology from the batteries to the charging infrastructure. And then add on top of that all the connectivity and communications and protocols as we talked about in the prepared statements. So, this is really a great intersection of multiple strengths for us and it has it has long-term secular growth drivers behind them.

[David Ridley-Lane, Analyst at Bank of America Merrill Lynch]

Thank you very much.

[Operator]

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

[Rob Mason, Analyst at Robert W. Baird]

Yes, good evening, thank you. Neil, I wanted to just clarify, you mentioned that R&D I thought would be roughly 16% of revenue this year. I just want to make sure that's correct because that's about a point more than it was this past year in '22 and just I'm curious how that steps up in what is an exit rate look like if that's the case?

[Neil Dougherty, Executive Vice President and Chief Financial Officer at Keysight Technologies]

Yeah, so you're right. Obviously, our 16% or 16% plus has been our long-term target. We underspent that here in FY '22. I think a big function of that was the revenue outperformance within the year. If you remember this time last year, we guided to 6% revenue growth on the year and we actually grew 12% on a core basis. And so our R&D plans for the year were much more aligned with that lower level of revenue growth.

So, I think as we go we certainly continue to see a large amount of opportunity for us to continue to invest in the future growth of our business. A lot of pull from our customers to do R&D work and so our intent is to re-ramp back towards 16% of revenue. Obviously, the salary administration here in the first quarter is going to help to move us in that direction. We may not get to 16% here in the first quarter but looking at an exit rate that's at 16% or even potentially a little bit above by the time you get out to the fourth quarter is not out of the question.

[Rob Mason, Analyst at Robert W. Baird]

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

[Neil Dougherty, Executive Vice President and Chief Financial Officer at Keysight Technologies]

Well, I certainly think over the longer-term that as the supply chain normalizes, there will be an opportunity for us to reduce some of the working capital that's built-up over the course of the last year. We see it in terms of inventory, increased inventory via the prices that we're paying for parts, we see money tied-up in terms of commitments to buy future inventory where we paid an advance for future delivery, it' been use of working capital that frankly is new over the course of the last 12 months and then frankly, the supply chain situation has significantly impacted the linearity of our revenue within the quarter.

You can imagine when you move from more of just-in-time environment where you're just building and shipping and building and shipping, we're doing a lot more build to a certain stage, wait for parts, finish and ship. And so our revenue has tended to be more back-end loaded, which results in us carrying more receivables at the end-of-the quarter than we would if we were shipping in a more linear fashion. So again, I think it's a function of how does supply chain normalized and when does that eventually happen. That is you need a little bit of a crystal ball to answer that question, but when it does happen, we would see -- we would expect to see an ability to reduce working capital.

[Rob Mason, Analyst at Robert W. Baird]

Very good. Thank you.

[Operator]

Thank you for your question, sir. That concludes our question-and-answer session for today. I would like to turn the conference back to Jason Kary for any closing remarks.

[Jason Kary, Vice President, Treasurer & Investor Relations at Keysight Technologies]

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