Broadcom Inc (AVGO) — Q3 2018 Earnings Call Transcript

Thank you, operator, and good afternoon, everyone. Joining me today is Hock Tan, President and CEO of Broadcom. Today, Hock is going to give you a detailed review of our core business and spend some time outlining the industrial logic behind our recent acquisition of CA. I will then spend time reviewing our Q3 results and Q4 outlook, and most importantly our financial model and capital allocation policy. Quickly on the formality. Today's call will primarily refer to non-GAAP financial results. A reconciliation to U.S. GAAP measures is included in today’s press release, which is available in the Investors section of our website at broadcom.com. Information on risks that could cause actual results to differ materially from the forward-looking statements made on this call is also available in today’s press release and in our recent SEC filings. This conference call is being webcast live. A recording will be available via telephone playback for one week and archived in the Investors section of our website at broadcom.com. At this time, I would like to turn the call over to Hock. Hock?

Thank you, Tom. The strength of our business model delivered another quarter of very sustained revenues, strong earnings, and free cash flows. Consolidated net revenue for the third quarter was $5.07 billion, a 13% increase from a year ago, and EPS came in at $4.98, a 21% increase from a year ago, while free cash flow at $2.13 billion is 42% of revenues. We have a lot to cover today, so let’s dive right into the segments. Starting with wired. In the third quarter, wired revenue was $2.3 billion, growing 4% year-on-year, and this segment represented 45% of our total revenues. Third quarter wired results reflect strong year-on-year growth for both our networking and compute offload businesses, driven by robust demand from the cloud data center markets, as well as traditional enterprises. Networking and compute offload represented approximately 60% of our total wired segment in the quarter and grew over 10% year-on-year. This is off the back of growing over 15% annually in the second quarter. So, this part of the wired segment is doing really well. However, cyclical headwinds in certain parts of our broadband businesses have impacted year-on-year growth for the wired segment. While digital subscriber line or DSL demand remained stable, demand for PON, fiber-to-the-home in China, as well as video access, particularly North America, has been soft compared to a very strong 2017. As a result, broadband was down year-over-year in the third quarter after being down in Q2 as well. Turning to the fourth quarter fiscal 2018, we expect networking and compute offload to continue to grow double digits year-on-year as strong demand from both the cloud and traditional enterprises sustain. However, cyclical headwinds we have seen in video access, including cable and satellite, are persisting into the fourth quarter. And as a result, in the fourth quarter, we expect wired to grow only mid-single digits year-on-year. But on the other hand, we’re very encouraged by the prospects for fiscal 2019. We expect strong growth in our networking business to continue, driven by new product ramps of our Tomahawk 3 switch and our Jericho2 router platforms. We also continue to see strength from our deep learning ASICs with our cloud customers. And we forecast broadband video will bottom this third quarter as we start to enter an upcycle in 2019. On enterprise wireless access too, we expect to be the first to enable the integrated 802.11ax chipsets during this coming year among service providers, enterprises, and homes. Let me now turn to enterprise storage. For the third quarter 2018, enterprise storage revenue was $1.25 billion, representing 25% of revenue. As we have experienced and mentioned in our wired networking business, robust enterprise IT spending drove over a 70% year-on-year revenue increase. This, of course, includes contributions from Brocade. But even without Brocade, storage was robust year-on-year in the third quarter. Looking in the fourth quarter, strong demand from enterprise continues to be good, and we expect year-on-year storage revenue growth to accelerate. Moving on now to wireless. In the third quarter, wireless revenue was $1.3 billion, which was flat year-over-year. The wireless segment represented about 25% of our total revenue. In aggregate, wireless revenues were in line with our expectations for the third quarter. We benefited from the initial seasonal ramp at our North American OEM customer, which was partially offset by anticipated declines at our other large wireless customer. We expect this ramp at our North American OEM customer to drive wireless revenue to be over 25% sequentially, given it may be down single digits year-on-year. Let me take some time to put this in perspective. Like all our franchises, our RF frontend business, which makes up roughly half of our wireless segment, competes very well based on its technology leadership and its ability to deliver differentiated, high-performance products, generation after generation. To generate the high returns we expect on our substantial R&D and manufacturing investments, we focus on delivering the best FBAR technology in every new generation of smartphones. Nonetheless, from time to time, not that often, but from time to time, the same technology platform used by our customer may expand beyond one generation. And when this happens, it does create an opportunity for a customer to temporarily use lower-performance alternatives in selected SKUs. With the benefit of hindsight, these may be precisely what happened with this 2018 generation. But every indication we have is that the cadence of annual platform upgrades will resume in the upcoming 2019 smartphone generation. And with 5G on the horizon, we expect this cadence of annual upgrades to sustain. As a result, we are maintaining our high level of investment as the market transitions to 5G. Meanwhile, in WiFi, Bluetooth to transition to 802.11ax continues to keep us in the lead. We believe we are very well-positioned to sustain this particular franchise over the next several years. And accordingly, we expect to see our wireless revenue returning to double-digit growth in fiscal 2020, following a temporary dip in fiscal 2019. Finally, our last segment, industrial. In the third quarter, the industrial segment represented 5% of total revenues. Excluding IP licensing, the industrial business was up over 10% year-on-year. Distribution resales continued to be strong with double-digit Q3 year-on-year growth. We expect demand for the industrial to remain strong, and industrial resale to maintain double-digit year-on-year growth during the fourth quarter. So, in summary, we continue to execute well on our business model. More than half our consolidated revenue, as you may note, is benefiting from strong cloud and enterprise data center spending. This, coupled with a seasonal uptick in wireless, will drive our forecast revenue in the fourth quarter to be $5.4 billion, an increase of 11% from a year ago. In the meantime, our margins continue to expand due to our focus on technology leadership and high-performance products. This is all driving exceptional cash flows, which provides us great flexibility in our capital allocation model of returning cash to shareholders through dividends and share purchases, while enabling us to pursue strategic acquisitions to expand our earnings capacity going forward. Speaking of acquisitions, before I turn this call back to Tom to talk about the financials in greater detail, let me perhaps take a few more minutes and talk about CA Technologies. The number one question we get when we get with CA is, why did we choose to buy? Cut to the chase. We’re buying CA because of the customers and their importance to these customers. CA sells mission-critical software to virtually all of the world’s largest enterprises. These are global leaders in key verticals including financial services, telecoms, insurance, healthcare, and retail. And CA does it at a scale fairly unique to the infrastructure software space. This can only come from longstanding relationships with these customers that have spent several decades. In other words, these guys are deeply embedded. Now, Broadcom does a lot of business with the cloud companies, building the digital economy, the leaders. Google, Amazon, and Microsoft are all large customers for us. They’re growing rapidly, and as you notice, we are growing even faster. They use our leading-edge silicon solutions to develop their next-generation data centers to enable many businesses worldwide. On the other hand, when you look at the largest enterprises, which comprise CA's customers, these guys really have limited direct access to a mission-critical technology. In that lies what we think is a new and huge opportunity. Just as we have done with hyper-cloud players, we believe we can bring our compute offload solutions, our Tomahawk switches, Jericho routers, fiber optics, and our server storage connectivity portfolio directly to these same large enterprises that are buying CA software. These large end-users invest tens of billions of dollars on IT infrastructure every year. Through CA, we believe we have a big doorway to engage strategically with these customers and provide them direct access at very compelling economics to the same leading-edge networking, storage, and compute technologies that are used to enable the cloud service providers today. Beyond this industrial logic, I might note, CA by itself is a great franchise. Mainframes remain the backbone of the enterprise computing environment and are relied on to run mission-critical applications. Mainframes process approximately 30 billion transactions per day and $7 trillion of credit card payments annually. Contrary to popular belief, over the last 10 years, mainframe models have actually increased 3.5 times, driven largely by increasing amounts of data generated with every single transaction. Given mainframes are among the most important parts of large enterprises, we believe this will remain a strong and stable market opportunity for us for the long term. CA is a leader in delivering a suite of mainframe solutions across application development and IT operations management tools. So, bottom line, we actually see this opportunity as a great opportunity, I may say, to double down for future growth. With that, let me turn the call over to Tom at this time.

Thank you, Hock, and good afternoon, everyone. My comments today will focus primarily on our non-GAAP results from continuing operations, unless otherwise specifically noted. Let me walk through our results for the third quarter of fiscal 2018. Third quarter net revenue was $5.07 billion, just ahead of the midpoint of our guidance. Our gross margin from continuing operations was at the high-end of our guidance, at 67.3%, as we benefited from the more favorable product mix in the quarter. Operating expenses were slightly lower than we expected at $874 million, driven by lower SG&A. As a result, operating income from continuing operations for the quarter was $2.54 billion and represented 50.1% of net revenue. Adjusted EBITDA for the quarter was $2.71 billion, representing 53.4% of net revenue. For housekeeping purposes, Q3 depreciation was $129 million. Below the line, net interest expense was slightly better than guidance due to high-interest income from our cash deposits. The tax provision was in line at 7% of operating income from continuing operations, or $170 million. The diluted share count was 453 million shares and includes the weighted average impact of the stock repurchases completed in the quarter. As a result, the company delivered $4.98 of EPS in the quarter. This represents 21% year-on-year growth, including the impact of share repurchases. Working capital, excluding cash and cash equivalents, increased approximately $209 million compared to the prior quarter, due primarily to an increase in receivables. This increase was driven by seasonally higher shipments in the last month of the quarter, as well as the effect of a distributor consolidation program for the Brocade business where we are providing a temporary extension to payment terms to facilitate the consolidation. In addition, cash restructuring expenses were $18 million, as we are now at the tail end of the Brocade integration. Finally, we spent $120 million on capital expenditures, which was slightly below expectations. As a result, free cash flow from operations was $2.13 billion, or 42% of revenue. This represents a 52% year-over-year growth in free cash flow from operations. In the quarter, we returned $754 million in the form of cash dividends and spent $5.38 billion repurchasing 24 million shares of AVGO. We did not pay down any debt in the quarter. We ended the quarter with $4.14 billion of cash, $17.6 billion of total debt, and 438 million fully diluted shares outstanding. Now, let me turn to our non-GAAP guidance for the fourth quarter of fiscal year 2018. This guidance reflects our current assessment of business conditions, and we do not intend to update this guidance. The guidance is for results from continuing operations only. Net revenue is expected to be $5.4 billion, plus or minus $75 million. Gross margin is expected to be 67%, plus or minus 1 percentage point. Operating expenses are estimated to be approximately $394 million. The tax provision is forecasted to be approximately 7%. Net interest expense and others are expected to be approximately $125 million. The diluted share count forecast is for 436 million shares. Capital expenditures will be approximately $110 million. Before we open the call for questions, I want to update you on our financial model and capital allocation policy. On the financial model, there have been a lot of questions regarding our long-term growth and concerns about the growth rate of our core semiconductor business. The intention with the CA announcement has not been to signal a change in the growth rate of our core business. On the contrary, we believe our long-term growth rate for the semiconductor segment will remain mid-single digits, driven by end-market growth and content increases from new product introductions. As we acquire businesses outside of semiconductors, including Brocade and more recently CA, we are taking a conservative approach relative to our internal expectations on revenue growth. The returns we model do not require significant growth to hit our targets, but make no mistake, we do expect to grow these businesses. So, the important message is that we do not see any fundamental changes in our long-term growth rate. Now, on the capital allocation. Here at Broadcom, we have a set of complementary, highly-profitable technology franchises that require limited capital expenditures, and it sits on top of an efficient corporate platform. This, in turn, sits at a substantial and sustainable base of cash flows that we expect will grow over time. This expected cash flow generation provides us with a lot of flexibility on how we allocate capital to create value for you, the shareholders. We are committed to our policy of distributing 50% of our prior fiscal year free cash flow to shareholders in the form of cash dividends. Given our fourth-quarter outlook and expected full fiscal year ’18 results, we anticipate another substantial increase in the quarterly dividend for calendar 2019. Now, with the remaining free cash flow, we see the opportunity to do a couple of things. One, we plan to continue to buy back shares. We currently have $6.3 billion left in our $12 billion stock repurchase authorization that extends through the end of FY19. And two, with the focus on maintaining our investment-grade credit rating, we believe we also have the cash flow and the borrowing capacity to continue to expand our earnings base through strategic and accretive acquisitions. Finally, as previously announced, we have cleared HSR with respect to the CA transaction in July. The transaction is still subject to CA shareholder approval and antitrust approvals in the EU and Japan. We expect to close in the fourth calendar quarter of 2018. That concludes my prepared remarks. During the Q&A portion of today’s call, we request you to limit yourselves to one question each. So, with that, operator, could you please open up the call for questions?

Hi. This is Pradeep on behalf of Timothy Arcuri. I had a question more on the longer term view of CA and the wireless solutions group. And how you view the wireless solutions group from a strategic standpoint, given that the CA acquisition is kind of focusing you guys towards more of an infrastructure company?

That’s a very interesting question and it offers me the opportunity to clarify how we look at our composite set of businesses. Our business model is very much focused on putting together a portfolio of what we consider product technology, product franchises. And that’s not necessarily limited to IT infrastructure or networking or data centers in any particular specifics. As you notice, we have a range of products that sell into multiple end markets which ranges from wired and, even in wired, we have made a distinction, as I said, of networking, data centers, as well as more service provider spending as it relates to carrier access, PON, and video delivery, and the two sets of end markets by itself. Then, we have enterprise storage, which is very data center-centric. But then, you’re right, we have wireless, which is, as we define it, very focused on mobilities and smartphones where we put up the best latest technology. And finally, we have industrial where we have a set of products that go to various industrial products, necessary to make that the data centers. So, they are very disparate; they are very diverse. And there in our view lies our strength. It’s a very set of diverse products, franchises, and that’s the key to operating these franchises. But each of them is very much a set of common characteristics. One is, they operate in niche markets typically, those are the niche markets that become mass markets, because mass markets have moved over to these niche markets. And for two, we have the technology; we are the leader in technology in each of these niche markets. And we tend to have the highest market share too in each of these end markets. And the common thing we do is they all sit on our platform, but each of those features, we keep investing, and you’ve seen the level of dollars we invest. We’re investing over $3 billion, $3.2 billion a year just on R&D and product development as we move through each generation and evolve the technology for use by end customers. And we make sure we lead in each of those. And so, we believe, to answer your question specifically on wireless, we believe our position in wireless, in those wireless products and markets, that we are very much in the lead in technology and our lead in market share in the niches we are in. So, it’s satisfying those considerations of us of franchises in those specific markets as you would apply to switching and routing in data centers where we’re also very well represented too. And the benefit of all these particular franchises is they all are enormously profitable and they all continue to grow.

Hey, Hock, and thanks a lot for taking my question. So, I’ll ask you about Computer Associates as well. So, you have demonstrated in the past a rather unmatched ability to create value from your acquisitions. And this is something you’ve mostly done in the semiconductor industry and that’s what you got, a lot of investors are used to. So, today, it’s really clear that we need to better understand the Broadcom model, how Broadcom can create so much value from acquisitions and how it can apply to CA? So, in that spirit, my question to the two of you, Hock and Tom, would be, can you tell us what you guys do that nobody else does? What makes you unique at integrating the business? You acquire and create value from these businesses like nobody else and in particular, like private equity firms for instance would not be able to do? And then, of course, put that in the context of Computer Associates. How are you going to apply these unique capabilities to Computer Associates?

Thank you, interesting question. Let me try to address that, if I could. One of which, to start with, we don’t own private equity, by no means. Why? We understand the businesses that operate in Broadcom very well, and we operate those businesses. We are not financial investors. The financial performance, the capital allocation that come out, the exceptional cash flow we generate of those making those businesses very successful happens to be just the end product. We run those businesses, and we run them as a group. That’s the biggest difference between us and private equity, very, very much. So, the way we see some differentiating tricks in how we identify and acquire those businesses and then integrate them into a whole, as part of Broadcom, is simply this. I think we’re very, very aware of our ecosystem, what product lines, what markets are very sustainable, very good as potential profit and growth opportunities. And we’re very focused. And that’s a key thing. We are very focused in determining what businesses make sense to invest in and what businesses we do not or should not invest in because it won’t generate the return, which is why, as I explained on my reply to the earlier question, today, Broadcom comprises 19 separate product divisions. Each of them is a leader in their own right in each of those niche markets they are in. And by being extremely focused on continuing to be the technology and market leader, which basically means delivering generation after generation. Because one advantage in technology is you keep having to evolve with better and better products that your customers can use and/or ask for. As you do that you actually create more and more value to your customers. And the extension of that is shown by the fact that if you look at our financials over the last several years, we expect our product margin, gross margin, to say as a collective whole, 100 basis points approximately every year. This is the same product. This is not about adding new acquisitions, which accrete the gross margin. We're talking about if you look organically at the same products that we have 3, 4, 5 years ago, you will see that margins expand as a whole. And the reason it can expand is because you're delivering more value to your customers. And so the real basic thing is be very focused. Stick to what you do very well and focus on where you are very successful and keep doing the same thing. And what we do when we look at acquisitions is very simply is we look at companies where the opposite is actually sometimes happening, where the core business of the Company – of some of these business companies are not so focused on or neglected in many ways, and instead the bright, shiny objects get focused on where the strength of that particular company may not be so good. And we basically pull them back to their roots and put them into as part of the overall Broadcom portfolio. That's really what we are.

Hock, one of the biggest questions that we've gotten especially more recently is on the semi-cycle. Now I understand you have 19 or so franchises that you can argue are more specialized, but I think you're certainly exposed to the broader trends in the industry. And there's an expectation that we're seeing a slowdown, in particular, in China, especially potentially related to tariffs. And I'm wondering if you can offer a comment as to where you think we are in that cycle, what you see going on in that regard.

That's a very good and timely question. I’m not trying to predict too far into the future, but we observe that the dynamics in the semiconductor space are constantly changing. This may seem obvious, but it varies across different end markets. We're fortunate to sell into four or five very different markets, and over the last two years, the behavior of those markets has varied significantly. Therefore, it's challenging to assess the overall semiconductor industry since it encompasses many areas. A couple of years ago, I mentioned that in 2016 and 2017, broadband was very strong, influenced by service provider spending levels worldwide, but this has become more cyclical and somewhat flat but sustainable. Currently, broadband isn’t as strong. Two years ago, data center spending was decent, but this year, it is extremely robust and looks promising. We observe different parts of the cycle. Wireless was thriving two to three years ago, with content growth. However, in the past year, the smartphone market has flattened out, with cost considerations overtaking demand and limited innovation, leading people to wait for a potential 5G cycle before we see growth again. Automotive has been impacting industrial markets for a few years, and we continue to witness a slowdown in both sectors. Thus, there are ups and downs across various segments using semiconductors. Our diversified approach helps us maintain stability and security overall, rather than being overly affected by fluctuations in any single end market.

Hock, maybe the short way to ask my question is does this operating margin expansion story have a ceiling at some point? But I guess, the longer term or longer way to ask the question is I wonder if you can just talk a little bit about how you think about R&D. I think oftentimes, investors get fixated on R&D as a percent of revenue and forget that at your scale, your absolute dollar spend is just enormous. But help me understand, is there something about your IP portfolio that gives it more leverage than a typical digital or SoC company? Or why are you able to drive so much more leverage out of your R&D line than many of your large peers? And again, as you answer that question, maybe you can talk about is there a ceiling to this op margin.

That's a great question, John, and I'll try to address that. You're right. It starts with IP. We sell intellectual property except with productizing. In many, our business is semiconductors, and we sell IP embedded in silicon, is perhaps the simplest way to describe it. That's what we do. We don't try to license this out. We make it into products that address what our end-users, end-customers need to make or use or make into part of a system. And it's that intellectual property that drives the technology evolution because we keep feeding that machine. We keep enhancing and innovating on those technologies in any particular markets we're in. As I mentioned, we have 19 of those markets, and in each of them, we behave very similarly. We have a team of people, and in many cases, we have among the best engineers in the world, architects, and engineers in the world in each area – in the space they are in. We are among the best. And many of these – and these guys, the other side to IP, they have IP they have developed over the years and innovate to the next better thing. And we keep doing that. And the customers love to have these products because it makes them successful. It makes them more productive. It makes them do things that otherwise they can't do. And when you do that with each evolving technology, each evolving generation of technology, you basically get a higher value added to your product. Always do because you give your customer more value. I'll give you an example, right? The well-known Tomahawk 3 switch is a 12.8 terabit per second throughput switch. The previous generation, Tomahawk 2, was only 6.4, half that throughput. So you are able to put into a data center and on top of a direct of servers, twice the throughput, twice the capacity, twice the bandwidth. Do I – am I able to charge 2x the price? Of course not. That's not the way technology works. But we are able to obviously improve against our value simply by the fact that even as dollars, our price per terabit drops, on the total 2x terabit, the value of the product goes up for us, for the customers. If the demand, the usage consumption increases to use up all 12.8 terabits, the data center scale gets to scale out tremendously at a very cost-effective set of economics. That example applies across all 19 product lines and to bottom – at the bottom – at the end of it all, so because of that, our ability to provide better products and more value to our customers. Our product margins go up. And it goes up faster than the amount of R&D we pour in, and we pour in quite a bit to sustain that level of improvement. That leads to an improved operating margin and expanding operating margin. That's what we've seen. That's what has happened.

Hock, I wanted to focus on your wired business, both in the near term and the long term. In the near term, you did a great job of explaining some of the puts and takes between that 60-40 split of the fast-growing and slower-growing businesses. But to the extent it's 45% of your business today, and we look forward longer-term, how should we think about the growth rates of that 60-40, and what does it mean to the profitability of the Company, either on the gross or operating margin line as the growth rates seem to be so different between those 2 sub-segments?

Well, Ross, thanks for asking that too. But what you say is true right now. In 2016, I loved broadband. It was on an up-cycle. If you recall, there was the Summer Olympics floating around, and everybody was signing up for cable, cable access. So we were booming. That time paid. That thing outperformed data centers, networking, that is. Today, the cycle turned around. We look at broadband and say, 'Man, this thing is dragging me.' It's not. When the up-cycle happens as we fully expect within the next 12 months also, you'll be great again. So that's one of the interesting things about it, is looking at, say, even wired or even wireless. A lot of these markets' growth has their ups and downs, and especially if you look at a quarter and much less annually. Quarterly, even worse. What we have to keep realizing is these are all technology-driven applications and market-driven as better, more innovative technology comes in. It keeps expanding, some at a slower pace than others, but what it does is it adopts new technology, which allows us to keep adding more value as we progress through it, even though it goes through its ups and downs. And the key thing to all this is sustainability. These are all very sustainable end markets. The product we see today may be much better than the product in this end market we saw 5 years ago, and the product 5 years from now will be much better than the product we see today. But believe me, the end use continues.

I have a question for wireless RF. I mean, you play mostly at the high end of the market. Interesting developments in China, when I think of some of the local brands there, some impressive specs coming out, and as they start to ramp the volumes. So I just wanted to know if that potentially could change your opportunity set in RF in the China market over time.

A very interesting question, and it is, again, part of the whole franchise model. And then, yes, because again, in the case of wireless, we have very unique technology. We have very, very differentiated technology that allows us to produce very high-performance products in those smartphones. So far, it's been the super high-end smartphones that tends to use our products. I could see a situation where, especially with 5G coming into the mix, with all these different bands showing up, where 5G, you start running higher than 3 gigahertz spectrum bandwidth, you start to meet better and better RF components, especially in filtering, very much so in filtering, and we could see that being required across the board in many next-phase or next-generation 5G phones. Therefore, we can see that happening, in which case then, it starts to expand beyond just high-end phones, and you're exactly right in that regard. It’s happened before, a few years ago, when there were certain bands that were so critical, it could only be done using FBAR – very difficult FBAR technology, and for a while, that was pretty cool.

I just want to follow up on that wireless. You were talking about cycles and some years better than others. When you look at wireless, cellular, and then WiFi as 2 components. Just kind of curious, as you look out, you mentioned 5G. Maybe kind of what's the content story between now and a couple of years from now, when 5G will be a majority? And then on the WiFi side, can you just talk about the timing of that?

Okay. You asked two questions here, so let me try to address them separately. WiFi, in many ways, is a more stable, predictable evolution of the technology trends. Today, very much so, everybody uses the standard WiFi standard called 802.11ac, C as in China, and that's great. It's definitely an improvement from what it used to be 5 years or 10 years ago. But we have a new technology, a new protocol coming in called 802.11ax, which I may have commented on a couple of times in my prepared remarks. What ax does is, in a nutshell, it increases, in layman's language, the bandwidth. Huge. You can imagine running data streams wirelessly from your handsets upwards and uplink and downlink weighing over 1 gigabit per second, even 2 gigabits per second. You can get carried away. But what's even more interesting is it allows for multiple users simultaneously, which is always tricky. It requires a lot of technology, hardware, and software. We are in the lead in doing it, as I indicated. We are the first out with our product, they're working, we're designing, and we started launching it with multiple partners starting October next month. This year, starting with the retail routers and going on to enterprise access points and then operators by early next year. So it's a big thing, 802.11ax, and I bet you in the spring, you will find at least one big handset maker coming out big-time to push 802.11ax. And our chips will be right in those flagship phones. So, it's more predictable, and our technology is so strong. I have to say that we see ourselves in the roadmap of our key customers over the next 2, 3 years. More predictable as 802.11ax should go to a second wave and upgrade and all that. On RF, it's not that much different, except what's happening here more than anything else is over several years, we go from 2G, GSM, to 3G, and now – and then we have 4G that's been going on now for 6 years. There's actually demand, or kind of a demand, I might add, for even higher speeds, higher throughputs, lower latencies, more connections, that's what 5G is all about, which leads to IoT applications and all those applications we had dreamed about previously. Those are great. It's just that those are very, very difficult to implement. And in order to make it happen, one, in a nutshell, it will happen as it has happened in the past on 4G, it's your phone already runs 3G, 4G. You now have to put in additional components, additional capability to run an additional set of spectrum that is operating in 5G. Once you start doing that, you really will have issues of coexistence. You also have to reach out in 5G to frequencies that are much higher, much more difficult to produce, to put in a phone for communications, data communications. I'm referring to frequencies that go way above 3 gigahertz now as a first step. And as you go into more and more of these 5G phones, you have more frequencies, more requirements of components in the same limited space of a phone. So you start to have to innovate on your components to be able to put them in a phone, unlimited space, lower power, working very well together. That's where our capabilities, our technology in RF, especially FBAR, come into its own. Therefore, we see this as a sustainable franchise, especially for someone who is able to design and have the IP to design capabilities, components, that few people are able to replicate.

Just a follow-up question with regard to the wireless and some of the prepared comments that you made. You talked about expectations will return to double-digit wireless growth next year. You also talked about being in a position to win back some of the FBAR business. Can you reconcile those 2 comments? And is one dependent on the other? For the double-digit growth you're expecting next year, what are the assumptions behind that?

Chris, it's Tom. Let me just clarify the prepared remarks. What we were referring to is double-digit growth in 2020 off the back of a dip in 2019. And just also to clarify, we do feel really good about the prospects of winning back the business that we discussed, that we had lost in the current generation phone, which would impact the very back half of '19, but really would have an influence on the 2020 growth rate we discussed.

The big question we're getting is what is Broadcom's expectation running a software company? This is the first one for you guys in this area. Could you maybe talk about some of the strengths and challenges you see and maybe some of the plan around running this business? And then also, for the non-mainframe business, what kind of margin opportunity do you expect to see from, for example, enterprise solutions?

Well, I love this question. I'm almost tempted to tell you, hello, the same reason we've put together a bunch of businesses in semiconductor, what we call semiconductor solutions. On one extreme semiconductor solution, I am pulling simple hardware semiconductors, pure hardware analog components. To the extreme, it's not even silicon, in some cases, it's nanotechnology, it's indium phosphide, gallium arsenide, as in lasers, to the more well-known, well-recognized silicon SoCs, silicon on a chip there we built our routers and switches, and deep-learning chips on, with a lot of software, by the way on this thing, lots of software. I have – in our networking team, I have as many software engineers as I have hardware engineers, silicon solution engineers. In our video delivery business, video, which is basically a set-top box with cable modem, I have more software engineers because there are tons of different kinds of software that goes into a set-top box chip versus compared to hardware engineers. We understand software. CA, you're right, is all software. But a set-top box is, to put a number, over 60% software. If I have to look at the switch, I can make the switch as simple, programmable and install software-defined networks and write a lot of software specs to program this, and that's 70% software, 30% hardware. Or I could hard-code chips as I do in certain other versions of my networking business that are typically lower-end switches. In that case, I would say I have 80% hardware and 20%, 30% software. So it varies across a lot of spectrum. One thing that's common is technology. It's technology solutions you provide to your customers, who cannot operate very productively, very efficiently; they don't sometimes operate at all without that, and it's technology solutions that evolve over time; your ability to keep up with customer needs over time. We're very good at managing that. We are very good at understanding how to monetize intellectual property in technology. I think that's a common thing we have.

I think it would be helpful for either one of you guys to talk a little bit about the M&A philosophy going forward. I think, Tom, you did an excellent job in sort of reiterating the capital return policy. It sort of struck me on a lot of the questions that we got from investors were it was sort of a surprise at the size of the CA deal, given some of the prior commentary around maybe focusing on smaller M&A deals. So I just kind of open it up and I'd love to hear some philosophy, conversation about how you're thinking about maybe verticals or size or any of those things, if there's anything that's off limits going forward, or we should just think about the capital return policy only and nothing's really off the table in terms of M&A. And I'll just open it up at that.

Good question, Matt. The key message is that not much has changed. Our business model and the factors that drive the returns from our acquisitions remain consistent. We recognize that CA was a bit of a surprise and certainly larger than many anticipated, yet it was the right deal for us at the right time as we consider how to grow the Company's earnings base and create long-term shareholder value. Reflecting back, when we acquired LSI, we entered a significantly different business. At Avago, we primarily had a mobile and RF business, which has grown rapidly, but we branched into areas like key channel SoCs, preamps for hard disk drives, enterprise storage, and SaaS connectivity for the server market. These were sectors we didn't know well, but the attributes of those businesses allowed us to achieve the returns we've experienced, as Hock mentioned regarding intellectual property, barriers to entry, and business sustainability. We have since expanded our portfolio with smaller transactions and the recent acquisition of Brocade, which is a systems business primarily focused on software and has its own end-user sales team. This has really enhanced our understanding of end customers and what we can achieve with them. More importantly, it has demonstrated that we can effectively manage these businesses. Brocade's performance over the past year has been impressive, and we've been quite familiar with the business even before that time. CA aligns with a strategy we've maintained for several years, yielding significant value for shareholders. We intend to continue this approach. Of course, we are committed to our dividend, which is crucial for us. We have considerable financial flexibility due to strong operating cash flows, allowing us to pursue buybacks and engaging in value-accretive mergers and acquisitions, and we foresee opportunities to do so moving forward.

One of the things that struck me though in your initial comments, when you were talking about your new customer base with CA because they do open up a lot of clients that you don't have with the semiconductor business. You were talking about porting in some of your networking and compute solutions, storage solutions to them. But right now, you're selling semiconductors, and a number of your big customers, you mentioned them, Google, Facebook or Google, Amazon, Microsoft, build their own boxes using your silicon. I would imagine, most of CA's customers do not do this. So how are you going to port your – how do you think you could port your semiconductor products to these new customers without getting into boxes? Or are you thinking about that? Or do you think they will start up such endeavors to start porting through? So I guess I don't understand how your existing products are going to be ported to these new clients without some sort of intermediary or white box guy or something. Maybe I'm a little bit confused there, but if you could explain that, I would appreciate it.

Sure. I think that's a very, very insightful question you came out with, and you're right 100%. One, we're not interested in going to the boxes, you got that right, or systems. We don't need to do that. But we have the key ingredients. We have the chips, the engine. Take a box, be it in the industry that you're out to, any of those things. And we have the software. Or if you want to sum up all of these end-users now, and you're probably aware of that to some extent, some of the big operators now are starting to want to build their own data centers and they have come to us and asked us to enable them to build their own data centers. That's very similar. These guys are very, very aware of how the cloud guys are doing. The cloud guys use our own silicon engine – our own merchant silicon. In many cases, some of our initial – our software, SDK, by – in many cases, they even write their own software and they then go to ODMs, the ODMs in Taiwan, in China, anywhere else, to put a box to build a system, a box. We have to enable that. Obviously, we have to. The cloud guys do it. There's no reason why an operator like AT&T with Domain 2.0 cannot and is, in fact, executing on that basis or any other large enterprise users who build – who had to build out on their own scale fairly substantial data centers, why they can't even do that on their own because as Tom had said, the core IP, the core technology, which is the engine, the software. Everything else ties together, and there are lots of ODMs out there. You call that white boxes, I believe, and they have a choice of doing that or continuing to buy from their traditional sources. What we are able to do now with our direct access to CA customers is establish strategic and strong engagements with those end-users, and substantial end-user enterprises or end-users, who would want to start doing it themselves in order to not just do it at low economics, but to access directly the latest, call it, leading-edge silicon software products, technology, which will enable them to build data centers just as leading-edge as what's available in the cloud. But we have seen that requirement, that request coming in, and we are basically responding to it. This is not a pipe dream.

I definitely appreciate that you guys think very strategically about the deals you do, but if I just go back and think about your M&A track record over the last several years, it just struck me as being financial deals, first and foremost. And Hock, the playbook has been, at least my impression has been, you'd slash SG&A by a significant amount, you'd cut R&D while basically raising prices at the same time. And CA, given the kind of legacy nature of their technology, has a lot of people believing that this business may turn out to not be as sticky if you take the same approach. So could you just comment on that, please?

That's a question that I believe is misguided in multiple ways. First, our history of acquisitions shows that we integrate them successfully, turning them into strong financial returns rather than simply financial transactions. We manage these acquisitions under one umbrella, with a highly focused operational strategy. When you maintain that focus, you avoid overinvesting in areas like R&D and sales. A straightforward business model means you don't require extensive SG&A expenses; it's not about cutting costs but rather about streamlining processes and concentrating spending on R&D in order to stay ahead. This model has been successfully executed over the last six years through many acquisitions. We are very selective about which core businesses to invest in and which to divest. Companies that we don't see as sustainable tend to be the ones we let go, as they are often commoditized and lack competitive advantages. From a strategic perspective, we focus on businesses that we can succeed in, which is relevant even for CA. The mainframe business remains robust, with ongoing investments because many large enterprises rely on it for critical online transactions. This illustrates that our business model is fundamentally operational, with strong financial results stemming from a secure and sustainable approach.

Okay. Thank you, everybody, for participating in today's earnings call.

Thank you.