KEYSIGHT TECHNOLOGIE

KEYS
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Transcript : Keysight Technologies, Inc. Presents at Goldman Sachs Communacopia + Technology Conference 2022, Sep-13-2022 11:30 AM

09/13/2022 | 02:30pm

Presenter Speech
Mark Delaney (Analysts)

Okay. Great. Thank you, everybody, for joining us. My name is Mark Delaney, and I cover Keysight for Goldman Sachs. I'm very pleased to have with us Satish Dhanasekaran, the CEO of Keysight and Neil Dougherty, the CFO. Thank you both for joining us. Thank you.

Presenter Speech
Satish Dhanasekaran (Executives)

Thank you very much. Happy to be here.

Question
Mark Delaney (Analysts)

I thought to kick off, I'd love to ask you around the overall environment that the company is operating in Keysight had strong orders across several brand markets and geographies the last several quarters, and that's in spite of some slowing macroeconomic indicators that we can all read about in the newspaper. Why do you think that is? And do you think it's sustainable?

Answer
Satish Dhanasekaran (Executives)

Yes. Thanks, Mark. I think our strategy of being a software-centric solutions company clearly enabled us to make a series of moves over the long term that's positioned us for strength and say, our growth rates have been high single digits. So since spin and our EPS accretion, strong double digits for the long term. So that's been a strong track record for the company. But what it's enabled us to do is to invest to stay diversified in our exposure to different end markets and multiple growth themes in those end markets.

Let's start with the wireless 1 with 5G that gets a lot of attention, obviously, but the wireline technologies as well as we put a total solution stack together are continuing to grow with the progression in wireline standards, the investments in next-gen computing have been net favorable. And automotive for our industrial business has been very strong, along with the new wafer starts that are going on in semiconductor. So we look across our end markets. I think having the exposure to commercial communications, aerospace and defense and industrial markets continues to keep us diversified along with our own ability to attract new customers. We've had a considered effort to grow our customer base, and we've been steadily growing those new customers across the multiple geographies, which is providing top line strength and resiliency as well to the business.

Question
Mark Delaney (Analysts)

And maybe dealing on the point around being more of a software-centric business. There's been a shift over a number of years, and you've built up a larger recurring revenue business, I think, over $1 billion. Maybe I'll direct this one to you. But maybe just level how do you calculate recurring revenue? And how recurring is it really, right? Is it kind of an annual contract? Or is it multiyear contracts? How should we think about how sticky that might be?

Answer
Neil Dougherty (Executives)

Yes. We -- as you mentioned, we have over $1 billion of recurring revenue today, just north of 20% of the total company mix is recurring, and it's a mix. About 50% of that recurring revenue is software. And so that's either time-based software contracts, primary term would be a year, but we have examples significantly longer than that or the support contracts associated with perpetual software sales.

And then the other 50% of their recurring revenue is on our services business. It's a combination of things like our pay for technical support, extended warranties or just break fix calibration based on the very large installed base -- it's that last piece, it's a contractual in nature, but it's been proven to be very stable over an extended period of time, given the large installed base of equipment that we have out in the marketplace.

Question
Mark Delaney (Analysts)

Okay. So all those services is counted as recurring or only a piece of that?

Answer
Neil Dougherty (Executives)

Most of service not all of them.

Question
Mark Delaney (Analysts)

Not all of it.

Answer
Neil Dougherty (Executives)

That's correct.

Question
Mark Delaney (Analysts)

Maybe speaking on supply chain. It's been something that's been topical for a far too long and longer I think a lot of people would have liked. We said on the last earnings call, supply constraints have improved somewhat, but that is still a constraint on revenue. Maybe you can speak first on the chip shortage and what you're seeing on that front? And maybe you can talk about both what you've been doing to offset some of these shortages and any perspective you can share on when that may improve?

Answer
Satish Dhanasekaran (Executives)

Yes. I think we have been quite pleased with the actions we've taken since the onset of this chip shortage issue that we faced in '21 -- late '21, to really ensure that we have multiple ways of getting to the supply. And that is through our own second sourcing efforts internally. We've had to redesign parts for some of the complex products that we enable. And so our own efforts, along with the relationships with our suppliers have enabled us to deliver every quarter.

And sequentially, as we progress through the year, we've been taking up our revenue guide, and that's enabled us to deliver 9% effectively for the full year right now. And that's up from 6%, and you also include the effects of currency that we face. So it's more like 11% on a core basis. And so when I think about the supply chain, it's a tale of two worlds. As I said, anything to do with consumer electronics type of semiconductors, you can source them a lot easier and quicker right now.

The custom supply of FPGAs and analogue parts are still constrained. We expect that the predictability will continue to improve, but they will still remain constrained and -- but maybe the situation improves in the second half of '23. That's our best guess at this point or our best forecast at this point. But we remain confident that the actions we have taken now for the last 4 quarters would enable us to work through this constrained environment and deliver.

Question
Mark Delaney (Analysts)

Okay. That's good news. In terms of some of these other events we're now seeing from a supply chain perspective, right, you've had renewed equivalent lockdowns in China, especially in Chengdu, but I think maybe some other areas, there's the risk of energy cuts in Europe that we're all reading about and trying to better assess. Anything you can share on the situation in Europe or China, and is that a potential risk that we need to be thinking about?

Answer
Satish Dhanasekaran (Executives)

I think China COVID continues to evolve, right? That's on our radar we watch for. We continue to mitigate the actions that we've taken in the original Shanghai when that happened. I think we continue to work through those. As far as the energy situation in Europe goes, our exposure -- direct exposure to Europe from a supply perspective is fairly limited and contained so we don't have a huge manufacturing footprint in Europe at this time, most of our employees in the region work from home or could work from home if our sites were to be shut down on energy.

Question
Mark Delaney (Analysts)

Right. Companies have a pretty variable cost structure, there is a downturn, something I think sort of adjust more quickly just based on the way you're structured. I don't know if Neil, you can share any more context on how that's set up?

Answer
Neil Dougherty (Executives)

Yes, I think it's an underappreciated part of Keysight that we have a highly durable model that we believe is pretty resilient in a broad range of economic circumstances. First, I'd start with the top line, right? We're increasingly levered to R&D budgets rather than manufacturing budgets, which I believe makes the business far less cyclical than historically been. And then we've got secular growth themes in a wide range of our end markets, 5G, 400 gigabit, 800 gigabit AV EV, increasing aerospace defense budgets semi reonshoring the CHIPS Act, all of those types of things, I think, will help to provide at least a buffer against any type of macro correction.

I think your question really was more focused on the cost side of things. I think the single most important of our aspect of that is the fact that 100% of our employees have a variable proportion of component of their pay. -- It fluctuates with business performance. The 2 drivers are operating margin and organic revenue growth. And so in a macro event, if our business performance does start to wane, I have a natural and automatic and systematic governor on the single biggest component of my cost structure, which is our people, and we saw that really play out back in Q2 of 2020.

When we're shutting our factories in response to COVID, our revenues were down 18% that quarter because our factories were closed, but we only lost 500 basis points of operating margin that we're still highly profitable. So -- and then beyond that, about 50% of our manufacturing is outsourced, about 25% of our sales growth through an indirect channel. And so again, there are numerous ways in which our business can flex automatically without us having to take specific actions.

Answer
Satish Dhanasekaran (Executives)

Yes. Yes, I would just add that entering this quarter, we had about $2.5 billion of backlog, which provides us additional cushion to the business as well.

Question
Mark Delaney (Analysts)

Yes. No, that's great. And speaking on backlog, you've spoken to Australia's call about some pricing being built into that. Maybe you could frame how much pricing slowing through into the top line? And how sticky do you think this pricing is, right? I mean if the macroeconomic environment does slow, does that pricing stick? Or does that potentially get given back to your customers passing through maybe lower cost?

Answer
Satish Dhanasekaran (Executives)

Yes. I think the way we've thought about our value capture, it's really based on adding more value to our customers and enabling their time to market. So every year, what our customers get new products that we introduce. These new products have higher capabilities that give them a greater advantage, which we're able to monetize. So these new products are often introduced at better margin profiles.

That's been sort of the sustainable part of our value capture strategy. We have, as everybody has passed some pricing to our customers through inflation, some of that is still in our backlog and also will play out into '23 over time. Generally speaking, across many industries, including in the semiconductor, I think in response to inflation, prices have gone up, and nobody is expecting that to reset in any material way at this point.

Question
Mark Delaney (Analysts)

Maybe we could speak more on a handful of the end markets that we could speak with communications and going to 5G, it's got a wider set of use cases for 5G relative to what we saw with 3G and 4G. How big can some of these projects be that you're seeing things like O-RAN or 5G for industrial applications. And even if the traditional telecom spend tied to mobile applications were to slow? I mean, are these other categories may be large enough that they could offset that if that didn't back come to fruition?

Answer
Satish Dhanasekaran (Executives)

Yes. I think with 5G, Keysight's -- the number one point I want to make is Keysight's increasing exposure to R&D. It's an important part. I think we have, on a weighted average basis, the 5G business is more vector to R&D. And I think that's much more sustainable and secular with our customers. Our customers are continuing to innovate in Release 16, Release 17, starting to think about release 18. Some are also starting to think about what might come after 5G, which is -- all of this creates a steady stream of focus for them to deploy their R&D talents to. And so that's a very favorable dynamic for our business. We also have seen emergence of new activity to create chips across our customer base, which we think is very favorable. And it's primary trigger is 5G, but even broader.

I think all of the semiconductor activity and design has been net favorable to our business because people need new solutions and new tools for us. With regard to new applications coming in, I think that's a very good point because we see secular investments towards millimeter wave and the primary consumption of millimeter wave would be to private 5G network applications.

We're also seeing the emergence of more open virtualized technologies such as Open RAN, gaining traction as a way to provide more network capability that is not tied to a single provider of networking. I think those applications will continue to feed higher innovation that we will benefit from. So while the industry capital might peak at some point as deployments scale, we continue to think the R&D opportunity associated with 5G is long term in nature.

Question
Mark Delaney (Analysts)

Can you elaborate more on the comment about the R&D versus production test exposure within 5G? I mean where does that ratio generally set for the company overall? And what does it look like for 5G?

Answer
Satish Dhanasekaran (Executives)

For 5G today, our exposure in R&D, 70% of the business is in R&D labs of our customers. It's very different than even the weighted average at the Keysight level was 60% in the R&D labs of our customers. So we continue to see opportunities to continue to grow it. And also, I want to add that a lot more of the 5G opportunity is rich with software, and we're working on converting a lot of that into recurring ARR models as well with our customers.

Question
Mark Delaney (Analysts)

Do you think we've observed some slowdown in consumer end markets, especially smartphones, right, which is one of the bigger use cases traditionally for 5G. I mean I recognize you're 70% tied to R&D. Do you think there's any risk to your 5G business when you think about what's going on with smartphone demand? Or is the R&D part of the business typically pretty sticky?

Answer
Satish Dhanasekaran (Executives)

Yes, the R&D parts of the business is sticky. Obviously, the rest of the business has some exposure to components that are used in production. And so if smartphones do slow down for a longer period of time that there will be some exposure there. But I do think that the recent deployment activities in the U.S. and now the announcement by India that they're going to basically embrace 5G and spectrum that's been just embraced, we think provides some stability to that business as well under these conditions.

Question
Mark Delaney (Analysts)

You touched on 6G. So be interested in learning a little bit more on that? And what does anything to hang on to some of the share that you -- or even grow your share further, right, when from 4G to 5G Keysight picked up a lot of market share. It was a big success story for the company and I think it's been reflected in the stock price over the last several years. But with 6G, when do you expect that to come? And how well positioned do you think the company is?

Answer
Satish Dhanasekaran (Executives)

Yes. I think 6G, the first and foremost, the vision for the technology is broader and bigger, right? I think you look at the goals of 5G, and you say, well, okay, from a technical complexity, the goals of 6G are much more complex. But also you look at some of the societal impairments, whether it comes to climate change, and how much energy consumption in communication networks is a big topic of investment with 6G. And we also would add to that applications like the metaverse, which need low latency networks and a very different type of communication networks for the future. So you add to all of that, I think it forms a bigger vision for what 6G, which means there's going to be more complexity and more areas where Keysight can expand its contributions, and we're well positioned to do so because we have the full technology stack in 5G, and we'll continue to evolve that to -- and we're investing right now in early capabilities for 6G and working with industry and with our customers. So we're well positioned to capitalize on the 6G opportunity.

Question
Mark Delaney (Analysts)

You mentioned in one of the earlier part of the conversation, commercial comms, the wireline business, which is also pretty substantial. I don't know if you could size up the wireline exposure -- but within wireline, I think there's some hyperscale exposure in some of these applications like 400 and 800G, -- so maybe elaborate on how big some of these communities.

Answer
Satish Dhanasekaran (Executives)

Yes, the commercial communications business roughly evenly splits out between wireless and wireline as 2 major components, and they serve two different sets of customers that are innovating in parallel towards making the next-generation communication technologies. And what's important there is it's not just a onetime innovation, there's a continuous stream of innovation that kicks in, right? We've had 100 gig technology originally and then followed by 400 gig and then now 800 gig is in R&D.

That will get into production, and then there will be 1.6 terabits. So there's this continuous wave of innovation. First, consumers of that innovation are the data center on hyperscalers because they tend to be on the forefront of that innovation trend. And then the followers would be the telecom markets because the telcos do need the continuous evolution in wireline technologies as well. What's also been favorable for us since the acquisition of Ixia that we have the full technology stack, we can go up and down the protocol stack in wireline as well, that offers us the ability to give complete solutions to customers. And I also want to point out that there is considerable work happening in new processor architectures that are net favorable to us, new chip to types of chips, chiplets and other interfaces, high-speed data interfaces like PCI and memory interfaces, like DDR technologies continue to rev. So every aspect of that communication stack is being upgraded and will continue to play out into 6G and beyond, and we're well positioned to capitalize on that trend.

Question
Mark Delaney (Analysts)

Maybe you could shift gears a little bit speak on the automotive end market and to start, perhaps you could describe some of your capabilities in the automotive test space and who you see as your key competitors in the area.

Answer
Satish Dhanasekaran (Executives)

Yes. I think from a traditional auto has been a fairly new market for Keysight. Since then in 2015, we created a vertical that focused on automotive. And at the heart of our thesis was that we would automotive has an industry that was largely served at that time with Tier 2 players that did most of the innovation. And so they were the biggest customers for us. And 1/3 of the business today continues to be in manufacturing and that continues to benefit from the increased electronics content, especially with EV cars that continues to go higher.

And with the capacity being a big issue that automakers are trying to solve, obviously, our business there is benefiting from that. But the one that we're very excited about is the R&D opportunity in auto. And what used to be a captive set of Tier 2 players that largely did all the innovation, what we see is an inflection in auto manufacturers investing in organic capabilities in-house, right?

I think hiring more electrical engineers, retrofitting more labs, hiring more software engineers because software is increasingly will be the way value will be experienced by customers. And so for Keysight, EV and AV provide secular growth themes in the auto industry. And we've taken our power capabilities that we have in the company, and we've combined it with the Sign lab acquisition we've had, and we're providing not only tools to test cells and batteries, but also to emulate batteries if you're testing an infrastructure or emulate infrastructure if you're testing the battery.

So providing a total solution for EV. We've made a couple of tuck-in acquisitions that enhance our capabilities to serve the market. And with AV, we've taken some of our 5G stack capability that it's in our commercial communications business and deploying it to offer solutions for AV. Again, a very early trend but one that we believe has secular long-term potentials, and we're already have pretty strong results in the business, 6 consecutive quarters where we've grown at strong double digits, and we continue to see greater opportunities going forward.

Question
Mark Delaney (Analysts)

Maybe you could tell us within automotive, how much is the -- how much is exposed to these faster-growing areas like EV and ADAS? Is it 2/3 or.

Answer
Neil Dougherty (Executives)

About 1/3 of the business is tied to manufacturing, and we're talking about really testing electronic content. So that electronic content could be pointed at either an ICE vehicle or an EV vehicle as we're seeing electronic content and both increase significantly. And then the other 2/3 is more directly linked to the R&D labs of focused on autonomous and electrification.

Question
Mark Delaney (Analysts)

You mentioned there's newer areas are a well-established set of competitors? Or is this such a new area that it's sort of an emerging category, and it's hard to even say who your key competitors are and perhaps it varies.

Answer
Satish Dhanasekaran (Executives)

Yes. I think I would say that as automakers invest in new capabilities, they're going to set up -- we see already they're setting up labs that theoretical engineers are going to use. And in there, you could see more traditional competitors and our share positions would probably be about the same as the general market.

But I do think the -- we're continuing to innovate in solutions areas where we can be a lot more unique in what we do because of the fact that many of the automakers have relied on custom providers in the past to provide some tools that don't scale, but our ability to create more of a platform will serve as a differentiator in those areas like EV and AV, in particular, where the solutions opportunities will grow with time.

Question
Mark Delaney (Analysts)

Your talk a little bit on semi-conductors already. You mentioned the chips Act. Maybe you could expand on that legislation and what you're seeing in the semiconductor industry more broadly.

Answer
Satish Dhanasekaran (Executives)

I think the onshoring and reshoring activity is just picking up, right? That's the headline here. I think the U.S. chips act will help. But across the globe, I think there is a greater understanding from governments of the world in funding more activities to own or secure their supply chains. And I think that's a net favorable for us. We see new wafer starts. We talked about a key design win in the U.S. with one of the onshoring activity from our -- in our wafer test business. And in general, I think the move to offshore out of China is starting to kick in, and I think that's going to create more opportunities over the next few years to grow our business.

Question
Mark Delaney (Analysts)

I just want to speak on aerospace, defense and government. And I think the spoken to some strength, in particular, in space and satellite applications. I don't know if you could help us on that one. I mean when I think about that category overall, I mean how much is tied to space and what could that business do over time?

Answer
Neil Dougherty (Executives)

Yes. I mean I think the business is primarily tied to defense and government budgets, both in the U.S. and in Europe. It's about 50% U.S., 50% ex U.S. So on that portion of the business, we're certainly looking to positive trends in terms of multiple cycles now across both parties of increasing U.S. defense budgets and particularly on the research development test and evaluation line of RDT&E, which is the one that most directly links with the spend that will be directed at Keysight.

And then outside the U.S., obviously, we're looking at expansion on NATO. We're looking at increased spend commitments by existing NATO countries as a percentage of GDP on defense. And so I think all of that bodes well for kind of the long-term trajectory of this business. And then I'll let Satish comment, but you also brought up kind of the new space and space and satellite applications as well. It's a smaller portion of the overall total, but certainly an exciting opportunity as we look forward. And given that he's the engineer, and I'm not, I'm going to let him take that.

Answer
Satish Dhanasekaran (Executives)

Space and Satellite has been largely for us, an area where we've -- it's part of our Aerospace and Defense business, but largely a prime contract or U.S. prime contractor led business. And what's changed recently over the last few years has been the increasing trend of privatization of space or private sector participation space with a lot of start-up activity, but also established players getting into that sector. And so the innovation has progressed rapidly and so the number of electrical engineering labs.

Again, I go back to that R&D activity remains very strong in space and satellite. We have a strong footprint of starting from component test for space and satellite, all the way to module level testing of satellite communication systems. I think that portfolio continues to grow, and we'll continue to invest to benefit from it. The other inflection that Neil briefly touched upon is the geopolitical dynamic. I think the geopolitical dynamics right now really will favor strengthening budgets in the U.S. and in the Western nations that this business has been -- our Aerospace and Defense business has traditionally been tethered to, and we continue to outperform the GDP growth in that business. So -- and strong portfolio should continue to help us do that.

Question
Mark Delaney (Analysts)

That's helpful. I want to talk on software, we talked a little bit about it in various places throughout the conversation. But I think software revenue hit an all-time high last quarter, about 20% of total revenue. Maybe you could speak a little bit more on how you see the software percentage of your business trending over time?

Answer
Satish Dhanasekaran (Executives)

Yes. Clearly, the focus for us is to have software be a bigger part of our value delivery to customers. And it's in line with the trends we see playing out across our end markets. So the investments that we've made to shore up our talent in the company have been critical, right? 2/3 of our engineering workforce today is software. And that's enabled us to make those -- take this transition with our strategy that we have outlined to be much more software-centric and a solutions provider. I would say we have 3 different types of software in the company.

One is just applications that sit on measurement tools, roughly 25%. So you could assume the growth rates there are more in line with the core market growth. But the faster-growing parts of our software are associated with 5G, our wireline stack business, where we have to refresh the software at the rates the standards are refreshing. And so the continuous change in technology is a net favorable to that business, and we've been able to convert a bigger percentage of customers into recurring business model and support one software business, which is highly recurring in nature by which has no linkages to hardware, if you will.

But it's part of our analog simulation business where we are market leaders and the new position that we've entered into software test with the acquisition of Eggplant and we continue to see more growth potential with that. We announced 2 years ago that we were creating our own software sales channel really enable us to lead customers into that transition to more ARR that we can grow over time.

Question
Mark Delaney (Analysts)

When you think about your M&A strategy, the company has been accretive in the past, you have a bias in particular you're doing software acquisitions?

Answer
Satish Dhanasekaran (Executives)

Absolutely. I think software is 20% of the revenue today. I think we're -- we obviously see a future state where that's a lot higher. And a big part of that will come from emerging applications like 6G, which brings new content, but also M&A into adjacent spaces would be a focus for capital deployment.

Question
Mark Delaney (Analysts)

You said the 5G business is a little bit overweighted on that software metro relative to the 20% for the corporate average. I mean, how much more software exposure to some of these newer categories like 5G?

Answer
Satish Dhanasekaran (Executives)

Yes, some of the newer categories in 5G, especially the Open RAN, which is a highly virtualized offering that we have in the cloud as well, where 50% of the total value proposition of software. So that's the trend that we see, and we're continuing to feed it by having the right talent in the company so that we're innovating at the pace of our customers, but equally, the sales motion that's needed to be able to transact this business as well. So we made those investments to be able to realize that.

Question
Mark Delaney (Analysts)

I wanted to speak on operating margins, with you if I could. And the company has done very well exceeding its prior margin guidance of 26% to 27%. And you said from here, don't focus so much on that 26% to 27%, its more about leverage and think about the drop-through from here. So maybe talk about how to think about the operating leverage. But given that you're above your prior targets, are you going to hit some sort of ceiling where is it harder to get more economics? Or do you think you could continue to get that drop through as you go forward?

Answer
Neil Dougherty (Executives)

I mean I think right now, we continue to believe there's upside on both the gross and the operating margins. And yes, we put our targets in 2020 to get to 26%, 27%. We're going to be close to 29% this year and continue to believe that there's opportunities for us to do more. I'd point everybody back to the leverage model that we've been talking about now really since the spin, which is we grow mid-single digits or better, we can drop 40% to the bottom line, and that's a metric that we've achieved pretty consistently over this horizon. So until we get around to putting out some new targets, which at some point, we will. I'd encourage you to think about that leverage capability is the right way to think about the business over the longer term.

Answer
Satish Dhanasekaran (Executives)

I also want to maybe add one thing on the gross margin front, right? I think we are at 65% gross margin this year, and it's flat year-over-year. But what's embedded in that is obviously the higher part premiums we had to pay and also freight costs and other things that went up. So significantly significant inflation impacts there. So we would expect that as inflation starts to turn down, we would expect that to turn into a tailwind for gross margins. So we're -- we see more upside in gross margins, which should help us continue to grow the margin profile of the business.

Question
Mark Delaney (Analysts)

If you kind of reflect back on what's allowed the company to get to these kind of margin levels? Is it really just the volume has been consistently pretty good and so you're getting that drop through -- are there other things like mix or software end market exposure? I mean anything else that's playing a role in allowing you to have these kind of margins?

Answer
Satish Dhanasekaran (Executives)

I would say the first thing is growth, right? Our ability to consistently outperform our expectations that we have set is 5%. But if you look at it over the long term, we've done more like 8%, 9% consistently. I think that's clearly a factor. The second one is our focus on higher value segments of the market, which are much more sustainable, more in R&D, more with software. And equally important is our ability to monetize these things, right? I think that's in line with the value we offer our customers. And I would say the other part to the stability is also our ability to find new customers and attract them consistently every year. I think that those all of those part of the reason why we've been able to outperform.

Answer
Neil Dougherty (Executives)

The only other thing that I would add to that is higher value-added services, right? It's a migration to R&D, higher software content, complete solutions, absolute growth and then higher value services is on top of that.

Question
Mark Delaney (Analysts)

I think traditionally, correct me, please, if I'm wrong, but I thought the services business years ago was pretty far below the corporate average margin. You tend job of bringing that up to similar to the corporate average at this point pretty close.

Answer
Neil Dougherty (Executives)

It's a little bit below on the gross margin side, which it has always been, but now it's operating at corporate level operating margins. So we've done a lot to improve the profitability of our services offering over that period of time.

Question
Mark Delaney (Analysts)

Maybe just talk a little bit more on the M&A strategy. I mean, how active is that pipeline? And are you seeing good opportunity to find more tuck-in acquisitions?

Answer
Satish Dhanasekaran (Executives)

Yes. M&A strategy, clearly, we see some adjacencies to the markets we play in, our ability to feed more content through our sales channel, it's a big lever for us. And so we've been focused on those sorts of things. Higher software content is another attribute we look for. And over the last few years, we've seen the valuations are -- have gone up and we've remained very disciplined in some areas. We walked away because we felt like the valuations were not in line with what was possible.

So we remain disciplined on that front. But in the interim, we recognize that given all the talent shortages in tech, we recognize we saw some opportunities to do some technology tuck-ins that further our strategy in software tests, further our strategy in automotive. We've done those that we feel were net positive for us to continue the growth trajectory of the company. And as we start to see the valuation expectations moderate, we'll continue to look to make some acquisitions at the right value.

Question
Mark Delaney (Analysts)

I'm going to ask 1 more question and then I want to give the audience an opportunity to ask 1 or 2. Otherwise, I can ask on, if not. But for both of you, as you think out over the next year, what is something you think could potentially surprise investors or industry observers.

Answer
Neil Dougherty (Executives)

Well, I mean, I think the #1 thing we need to watch over the years is the uncertainty, right? And I think the positive thing about Keysight is we feel like we're well positioned to outperform the broader market really in broad range of economic circumstances. And so we don't exactly know what the next year is going to bring. Clearly, it's cloudy and there are a lot of warning signs. But I think our ability to execute no matter what happens, I think, is going to prove to as an important proof point for Keysight strengths.

Answer
Satish Dhanasekaran (Executives)

Well, I think it's really our focus as a company, right? Obviously, we've had a CEO transition this year. And we've architected it to be as seamless. It's the strength of the team, the leadership bench that remains in place that continues this philosophy of being first to market and remains focused on its customers. And I think that's been our formula for success, and we'll continue to deliver. And we remain, while we look at the long term, and we have targets for the long term, but we remain very focused on getting there every quarter along the way. I think that's something that we hold as very important for the organization.

Question
Mark Delaney (Analysts)

I want to see if there's a question or 2 from the audience.

Answer
Unknown Attendee (Attendees)

[indiscernible] on software anything related [indiscernible].

Answer
Neil Dougherty (Executives)

I mean so the question was about retention ratios and recurring revenue on our software portfolio. So about half of our software today is recurring in nature. And for those businesses that have time-based purchases or retention rates are very strong. The portion of it's not recurring. I mean Satish talk about it.

If you're buying an instrument, you load it up with applications at the time of purchase. And our retention rate amongst our solutions customers is also very high, right? We have customers that are committed to Keysight's platforms across the lab environments and whether that's hardware or software. And so I think there's a very strong intersection between the technology the Keysights bringing market and the investments that kind of broader tech is making across all of these key themes that I've outlined today.

Answer
Satish Dhanasekaran (Executives)

And we continue to drive that 50% number higher over time. We think there's more opportunities there.

Question
Mark Delaney (Analysts)

We have time for one more from the audience. Otherwise, I'll ask last one.

Answer
Neil Dougherty (Executives)

On the services, well, I mean, I think we don't treat services any differently than we treat the rest of the business. I think we look at the differentiation that we bring into the marketplace, and we want to make sure that we're capturing value from our customers. I do think that in this environment, given the inflationary pressures that have broad broadly felt across the economy, there has been an opportunity to just kind of directly pass on cost increases.

And I think you've done a good -- we've done a good job of that. We've basically traded broader on gross margins over the course of the last year at 65% which, as Satish said earlier, going into it, I think we felt like there was opportunity and there continues to be opportunity for gross margin expansion. But then if you look at what we actually faced over the course of the last year in terms of cost up, the fact that we maintained gross margins flat, I think, is an indication of the value that we're bringing into the marketplace and our ability to monetize that value and maintain margins in a challenging environment.

Question
Mark Delaney (Analysts)

Great. Well, unfortunately, we are out of time. Satish, Neil really appreciate you joining us today.

Answer
Neil Dougherty (Executives)

Thank you.

Answer
Satish Dhanasekaran (Executives)

Thank you, Mark.

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