Keysight+ESI = so far, so good

Feb 21, 2024 | Hot Topics

We’re deep into earnings season and getting a sense of where things stand. Most PLMish companies seem cautious about the near term, with more optimism about the second half of calendar 2024. I’ll try to do a recap soon, but today, I want to focus on Keysight, the company that last month closed its acquisition of ESI Group.

Last night, Keysight reported results for its FQ1 2024, which ended January 31. (It’s ironic that ESI just finished converting from a January 31 year-end to December 31 before the deal closed.) They weren’t awesome: Keysight’s total revenue for the quarter was $1.26 billion, down from $1.38 billion in the first quarter of 2023. The company reports in two divisions: Communications Solutions Group (CSG), which reported revenue of $839 million in FQ1, down 11% as reported, “reflecting a 14% decline in commercial communications, while aerospace, defense, and government [that’s one category for Keysight] decreased 5%” and Electronic Industrial Solutions Group (EISG), which reported revenue of $420 million, down 5% on “continued constraint in semiconductor and manufacturing-related customer spending, partially offset by the addition of ESI.”

Financial statements say ESI contributed $68 million to FQ1 — which the company said was about 10% higher than expected. In addition, CFO Neil Dougherty said ESI “saw strong renewal activity with some good upsizing of transactions and other things that drove that revenue nicely.” 

Keysight CEO Satish Dhanasekaran said, “We’re quite positive about the opportunities to grow the ESI business in Keysight’s environment. We’ve long studied the system simulation/emulation marketplace … Bringing an asset that was locked in in a European environment and exposing it with our go-to-market channel and taking that into our customer base remains an opportunity to drive growth above what they’ve been able to do.”

That all makes sense: ESI had struggled on its own in markets outside Europe, and having the deal done and uncertainty removed could lead to larger deal sizes, but it still begs the question, who is Keysight, and why did they buy ESI?

Keysight is typically considered part of the test and measurement (T&M) world — the technologies CAE sought to augment/replace. Today, Keysight makes oscilloscopes, meters, analyzers, and other hardware for physical testing in automotive, aerospace, semiconductor manufacturing, wireless communications, and other industries. The emergence of CAE led to a decline in physical prototyping and the need for T&M devices, which caused many of the T&M vendors to expand into software. For Keysight, that meant electronic design and test software. Before ESI, Keysight had printed circuit board (PCB), RF and microwave, 5G/6G, and similar design workflows under the PathWave, Genesis, GoldenGate and EP-Scan brands. For automated software application and user interface testing, their flagship seems to be the Eggplant Test Automation platform (I love this branding —not everything needs to be techie— but I have no idea why Eggplant.) According to company filings, software and related services typically represent about one-third of revenue and contribute significantly to overall profit.

But possibly most compelling is that software sales contribute to stability, smoothing out the ups and downs in end-markets that might not want to purchase capital equipment but need to keep software licenses running. 

Expanding further into software makes sense — what does Keysight plan to do with its ESI asset now that it has it?

In his opening remarks during the FQ1 investor call, Jason Kary, VP of Investor Relations, said, “[O]ur software-centric solutions strategy … is enabling business resilience in the current market conditions. Software and services orders and revenue continued to outperform the broader business this quarter and were greater than 35% of total Keysight, even excluding ESI. ESI further enhances our design engineering software portfolio and expands our addressable market in automotive, avionics, smart manufacturing, and human workflows. We were pleased to complete the acquisition ahead of schedule, and ESI’s results were also ahead of expectations for the quarter.”

Later on the call, Keysight CEO Satish Dhanasekaran said, “ESI is on track, transforming the business for growth. Our first priority is to continue to support their base plan. [Chief Customer Officer Mark Wallace] and his team have already started to engage in taking those capabilities and applying them to our aerospace and defense customer base in the U.S. as a first order of priority. [I also think] their core technologies around hybrid AI could find broader leverage into other Keysight applications to accelerate our pursuits — but that’s with time. Our number one priority is to stabilize, integrate, and basically keep their base plan on track. I think they’re off to a good start.”

Mr. Dhanasekaran ran through the various ups and downs in Keysight’s end markets (read the prepared remarks here https://s22.q4cdn.com/444849635/files/doc_earnings/2024/q1/transcript/Q1-FY2024-Prepared-Remarks.pdf) — my main takeaways are that spending on innovation (including design and CAE software) remains strong, while manufacturing-related spending remains cautious. All of that led the company to issue FQ2 revenue guidance of around $1.2 billion, including $25 million from ESI. Why such a steep drop-off from the $68 million in FQ1? Because ESI’s revenue has always skewed towards large renewals, in the calendar fourth quarter — so already done.

Mr. Dougherty said that he expects revenue to be “relatively flat” from FQ2 to FQ3 and then sequentially up in the mid-single digits from FQ3 to FQ4 — though he expects order intake in the second half to exceed first-half orders, “which will be supportive of revenue growth in 2025.”

In speaking to an investor about Keysight (he wanted to know about ESI; he taught me about Keysight), I learned that Keysight is already aligned with the R&D spending side of its customers rather than their capital (equipment) expenditures — which means that Keysight’s revenue isn’t as closely tied to ramping up in cellphone manufacturing, for example. That’s good when end markets are iffy but not as good when there’s a massive expansion in consumers buying cell phones. Steady growth was more critical to this investor than rocketing up (or down), but not all investors agree.

TL;DR? Bottom line: I like Keysight’s statements about leaving ESI alone to execute on its plans while also helping it reach more new customers outside Europe. 

Read more of Keysight’s earnings info here: https://investor.keysight.com/financial-information/quarterly-reports/default.aspx