Broadcom Inc (AVGO) — Q4 2020 Earnings Call Transcript

Thank you, Operator, and good afternoon everyone. Joining me on today's call are Hock Tan, President and CEO; as well as the senior leadership team as announced this afternoon, including Tom Krause, President, Infrastructure Software Group; Charlie Kawwas, Chief Operating Officer; and Kirsten Spears, Chief Financial Officer. Broadcom also distributed a press release and financial tables after the market closed, describing our financial performance for the fourth quarter and fiscal year 2020. If you did not receive a copy, you may obtain the information from the Investors section of Broadcom's website at broadcom.com. This conference call is being webcast live, and a recording will be available via telephone playback for one week. It will also be archived in the Investors section of our website at broadcom.com. During the prepared comments, Hock, Kirsten, and Tom will be providing details of our fourth quarter and fiscal year 2020 results, guidance for our first quarter, as well as commentary regarding the business environment. We'll take questions after the end of our prepared comments. Please refer to our press release today and our filings with the SEC for information on the specific risk factors that could cause our actual results to differ materially from the forward-looking statements made on this call. In addition to U.S. GAAP reporting, Broadcom reports certain financial measures on a non-GAAP basis. A reconciliation between GAAP and non-GAAP measures is included in the tables attached to today's press release. Comments made during today's call will primarily refer to our non-GAAP financial results. And with that, I'll now turn the call over to Hock.

Thank you, Bea. Before I discuss our results, I want to highlight the senior leadership appointments we just made this afternoon, which are aimed at ensuring the continued growth and success of Broadcom. I'm as committed and engaged as ever, and while you often see me and Tom, we have a strong team behind us that has helped us get to where we are today. We are promoting some of this talented team into key positions to strengthen our organization moving forward. Tom, Charlie, and Kirsten are among those who have supported our platform and the impressive numbers I’m about to announce. Starting in fiscal year '21, we are planning a series of analyst days focused on our various businesses where you can hear from our general managers. The first of these will take place this January with Ram Velaga and Alexis Björlin reviewing our networking franchise. Now, let’s move on to our very strong fourth-quarter results. We finished fiscal 2020 with record quarterly revenue and profitability despite the ongoing pandemic and macroeconomic challenges. We achieved net revenue of $6.5 billion, which is above our guidance midpoint, up 11% sequentially, and up 12% year-on-year. Semiconductor Solutions revenue was $4.8 billion, increasing 6% year-on-year, demonstrating a return to year-on-year revenue growth. Infrastructure Software revenue was $1.6 billion, up 36% year-on-year, including contributions from Symantec. In terms of semiconductors, Networking, which made up about 35% of our Semiconductor Solutions revenue in the quarter, grew by 17% year-on-year, driven by strong cloud data center spending and telco investments in upgrading Edge and core networks. Looking to Q1, we anticipate this trend of double-digit year-on-year revenue growth to continue, despite a softening in enterprise campus spending. For broadband, constituting roughly 14% of Semiconductor Solutions in the quarter, revenue was up 22% year-on-year, spurred by the work-from-home environment and the need from both service providers and consumers for improved broadband connectivity. We saw strong adoption of Wi-Fi 6 in next-generation access gateways among telcos and consumers. Wi-Fi has become a substantial and growing business for us. Additionally, we witnessed significant investments by service providers in GPON, copper DSL, and cable modems, which offset declines in video. We expect year-on-year revenue growth in broadband for Q1 to be in the low-to-mid teens as demand remains strong. Wireless revenue, accounting for about 31% of Semiconductor revenue in this quarter, increased by 43% sequentially in Q4, driven by the launch of a new flagship phone by a large North American OEM. However, it was down 9% year-on-year due to a production ramp-up delay. We expect Q1 fiscal '21 to be the peak quarter for this seasonal ramp, with revenue expected to significantly increase over the same quarter last year, likely up over 50% year-on-year. Server storage connectivity, representing approximately 14% of Q4 Semiconductor revenue, was down 9% year-on-year as expected due to weakened enterprise demand. We anticipate continued revenue decline in Q1, given a strong year-on-year comparison from fiscal '20, potentially down by double digits, even as much as 20%. Lastly, for industrial, which made up about 3% of Q4 Semiconductor Solutions revenue, we are seeing demand recovery, particularly from China, with consolidated resales up 4% year-on-year. We expect these resales in Q1 to accelerate to mid-teens year-on-year growth as the recovery in industrial and automotive sectors continues. To summarize, our Semiconductor Solutions segment grew by 6% year-on-year in Q4, driven mainly by strong wireless performance, along with resilient networking and broadband sectors. In Q1, we expect revenue in the Semiconductor segment to grow by high-teens percentage year-on-year, fueled by robust demand in these areas. Regarding software, our business model remains focused on the largest enterprise customers, aiming to increase adoption of our software products through a hybrid model, with about 90% being recurring subscription revenue. We've increased investment in R&D targeting these core customers while spending less on market outreach. After integrating CA onto our platform for two years, revenue for Q4 '20 increased by 5% year-on-year. For Symantec, excluding services and hardware, Q4 product revenue reached $380 million, up 10% from Q1 fiscal '20. Revenue from core CA accounts saw double-digit growth, about 12% year-on-year, driven by increasing bookings. This growth in core accounts has compensated for declines in services and attrition outside of core enterprise customers, which we anticipate will maintain our software business long-term, albeit with low-to-mid single-digit revenue growth. You'll hear more about our financial outlook from Kirsten later. Looking to the next quarter, we expect CA and Symantec software revenue to continue mid-single-digit growth year-on-year, while Brocade is expected to decline in the high single digits due to enterprise market softness, leading to infrastructure software segment revenue being flat or slightly up low single digits year-on-year. Overall, we expect consolidated net revenue for Q1 to be around $6.6 billion, an approximate 13% year-on-year increase, entirely organic. We find ourselves in a unique position with a backlog exceeding $14 billion as we start fiscal 2021, although the timing of converting this backlog to revenue remains influenced by a tight supply chain. Lastly, I want to express my gratitude to our team for their efforts in fiscal 2020. It has been a challenging year, but our employees have shown remarkable focus and resilience. Their dedication has made our mission-critical technologies more relevant than ever. Now, I’ll turn the call over to Kirsten.

Thank you, Hock. By way of background, while I've been a part of Broadcom for more than six years, my history in accounting and reporting roles for legacy companies of AVGO and LSI dates back over 20 years. I'm proud of the strong financial organization that Broadcom has built, and I look forward to working together. I know Hock just gave you the details on revenue, which I'll recap before moving down the P&L to discuss our fourth quarter performance, which clearly demonstrates our strong foundations for future growth. Consolidated net revenue for the fourth quarter was $6.5 billion, a 12% increase from a year ago. Semiconductor solutions revenue was $4.8 billion and represented 75% of our total revenue this quarter. This was up 6% year-on-year. Revenue for the Infrastructure Software segment was $1.6 billion and represented 25% of revenue. This was up 36% year-on-year, given the inclusion of Symantec. Continuing down the P&L, gross margins were 74% of revenue in the quarter, up approximately 370 basis points year-on-year. The expansion in gross margin year-on-year was driven by favorable product mix in semiconductors and a higher percentage of software revenue. Operating expenses were $1.1 billion, up 10% year-on-year, due primarily to the addition of Symantec. Operating income from continuing operations was $3.6 billion, representing 56% of revenue. Operating margins were up approximately 400 basis points year-on-year. Adjusted EBITDA was $3.8 billion, which represented 59% of revenue. This figure excludes $139 million of depreciation. Gross margins for our Semiconductor Solutions segment were approximately 68% in Q4, which is 320 basis points year-on-year, driven by an improved product mix. This mix included more networking products and less wireless. As you know, wireless carries around 10 points less margin on product profitability than the rest of our semiconductor portfolio. Operating expenses were $777 million in Q4, or 16% of Semiconductor Solutions revenue, compared to $727 million in the prior-year period as we continue to invest in our business. R&D costs as a percentage of revenue for Q4 was approximately 14%, and SG&A as a percentage of revenue was 2%. Operating margins for our Semiconductor Solutions segment was 52% in Q4, up 290 basis points year-on-year, all told in Semiconductor Solutions, revenue was up 6%, and operating profit grew 12%. Gross margins for our Infrastructure Software segment were 90% in Q4, up 130 basis points year-on-year. Cost of revenue primarily includes cost of product support, hosting for our SaaS products, professional services, and hardware. Operating expenses were $338 million in Q4, or 21% of Infrastructure Software revenue, compared to $290 million, or 24% of revenue in the prior-year period, as we generate scale through the acquisition of Symantec. R&D costs as a percentage of revenue for Q4 was approximately 12%, and SG&A as a percentage of Infrastructure Software revenue was 9%. Operating margin was 69% in Q4, up 480 basis points year-on-year. Our operating margins reflect our model, which is about focusing on the largest enterprise customers and increasing our share of their wallet in terms of our software portfolio. Given this model, we're able to focus our R&D investments on a strategic group of customers, and by doing so, reduce costs primarily on go-to-market. This is how we get to operating margins of about 69%, which we believe we can sustain. Looking at cash flow, we had quarterly free cash flow of $3.2 billion representing 50% of revenue. This is up 36% year-on-year as we managed our working capital more tightly during this pandemic. Moving on to capital allocation for Q4, we paid our common stockholders $1.3 billion in cash dividends. We also paid $185 million in withholding taxes due on vesting of employee equity, resulting in the elimination of approximately 500,000 AVGO shares. We ended the quarter with 407 million outstanding common shares and 451 million diluted shares. Note that we expect the diluted share count to be 450 million in Q1. On the financing and balance sheet front, we reduced total debt by $3 billion in the quarter. All told, we ended the quarter with $7.6 billion of cash and currently have $12.6 billion of liquidity including our $5 billion revolver. We ended the quarter with $41.1 billion of total debt, of which approximately $800 million is short-term. I'll now turn the call over to Tom.

Thank you, Kirsten. Let me now recap our financial performance for fiscal year 2020. Our revenue hit a new record of $23.9 billion, growing 6% year-on-year. Semiconductor Solutions revenue was $17.3 billion, down 1% year-over-year. Infrastructure Software revenue was $6.6 billion, which included $1.5 billion from Brocade, which was down 17% year-on-year, $3.5 billion from CA, which was up 4% year-on-year and inclusion of Symantec, which is $1.6 billion. Gross margin for the year was a record high of 73.5%, up from 71% a year ago. The addition of Symantec as well as a beneficial mix in semiconductor product sales drove the gross margin expansion. Additionally, operating expenses were $4.6 billion, which included the addition of Symantec. Operating income from continuing operations was $12.9 billion, up 8% year-over-year, and represented 54% of net revenue. Adjusted EBITDA was $13.6 billion, up 8% year-over-year, and represented 57% of net revenue. This figure excludes $570 million in depreciation. We accrued $644 million of restructuring integration expenses and made $583 million of cash restructuring integration payments in fiscal 2020. We spent $463 million on capital expenditures and free cash flow represented 49% of revenue, or $11.6 billion. Free cash flow grew 25% year-over-year. Now on the capital allocation; for the year, we returned $6 billion to our common stockholders, consisting of $5.2 billion in the form of cash dividends and $800 million for the elimination of 2.6 million AVGO shares. We also paid $299 million in dividends to our preferred stockholders. I would also note, through the refinancing and liability management activities we've undertaken this year, our weighted average debt maturity is now approximately six years, with a weighted average interest rate of approximately 3.5%. Looking ahead to fiscal 2021, we remain committed to returning approximately 50% of our prior year normalized free cash flow to stockholders in the form of cash dividends. With that, on the dividend, based on approximately $12 billion of free cash flow in fiscal year 2020, we are increasing our target quarterly common stock cash dividend starting this quarter to $3.60 per share. This constitutes an increase of 11%, and assumes a basic outstanding share count of 413 million shares at the end of fiscal 2021. We plan to maintain this dividend payout throughout this year, subject to quarterly Board approval. Consistent with our capital allocation policy, we'll reassess the dividend this time next year based on our fiscal '21 free cash flow result. With that, I'll turn the call back over to Bea.

Thank you, Tom. At this time, we'll open the call for questions. We have Hock, Tom, Kirsten, and Charlie available to answer any questions. So, operator, please go ahead and kick us off.

Yes, thank you. A question for Hock, I think on the call a year ago, you talked about an increase in R&D investment, and there were areas in cloud, photonics, I think wireless infrastructure. So just wanted to get an update on how that's progressing, and the visibility into revenue from that R&D investment?

That's a great question. Our investment strategy continues to focus on key strategic areas in various businesses, and you've seen some progress in this regard. For example, last week we announced the launch and ramp-up of our 800 gig platform for switching, routing, interconnects, and associated re-timers. This is significant because our earlier generation, the 400 gig Tomahawk 3 platform, which we introduced around a year and a half ago, is just now starting to penetrate the broader market, while we are already introducing the 800 gig version. The speed and consistency with which we are bringing this product to market is something we aim to maintain, with plans for releasing new generations featuring double the throughput capacity every 18 months to two years, as our hyper cloud customers demand. This approach is essential as we scale datacenters due to the limits of Moore's law. Additionally, we are increasing our investment in silicon photonics to enable very high-throughput interconnects, which is progressing very well. Though we are only in the second year of this multi-year investment, we expect to have offerings available in one to two generations of our switching and routing platforms. Regarding further investments, we've delayed our investment in Wi-Fi, focusing on the 802.11ax standard, which we successfully launched two years ago. We are also heavily invested in the upcoming Wi-Fi 7, a successor to Wi-Fi 6. In the meantime, we're rolling out six gigahertz Wi-Fi, known as Wi-Fi 6E, which recently received FCC approval, and we are proud to have our first product certified by them. We aim to lead in wireless connectivity, which currently constitutes a substantial and growing portion of our business, reflecting our commitment and success in this domain. Most of our investments are long-term, but you can already see some returns and product launches starting to materialize due to the level of investment we are making.

Thanks for taking my question and good luck to Tom, Kirsten, and Charlie in your new roles. Hock, the question is for you on supply constraints, that several of your peers in semiconductors had mentioned whether it's in substrates or wafers or foundry capacity. I'm curious, where does Broadcom stand on this? Is supply a factor in your reported results or your Q1 outlook or something that you think can constrain the growth in fiscal '21? Just what steps are you taking to make sure it doesn't constrain growth, and also, on the other side make sure customers are not double ordering because of all these supply issues? Thank you.

Well, interesting question. We reported on the supply constraint at least three months ago when we did our earnings call. Since then people will, as you correctly pointed out, so we have seen that supply constraint for six months, and we have taken a lot of actions to address it, and we continue to do that. As one of the largest consumers of third-party manufacturers in semiconductors out there, be they wafers, be they substrates, be they back-end assembly or test capacity, we are all in there. So best answer is we're managing that. We have the backlog in place, and we also very early on in our fiscal '20 stretched out our supply chain, not only based on what we've seen, but based on what we anticipate happening, and that has also enabled us to in a more orderly manner put products in the hands of end users who need it at appropriate times, we've done that very well. And having said all that, even as we do it, our backlog continues to grow. To give you a sense, I mentioned we have over 14 billion of backlog today. So it's accelerating. But having said that, please don't get carried away in the other aspect. As you know, our wireless business that we have is seasonal, so we are seeing obviously our wireless is a significant part of our total backlog, but given the seasonality of it we obviously have seen deceleration in the bookings that are coming in from our wireless business. But we are seeing on the other side acceleration and continued strength in orders coming in from the other parts of our business. Networking has always remained strong; broadband continues to be very strong. We're starting to see on the smaller part of our business, industrial coming in very, very strong. So one side is offsetting the other, and we continue to see this strong backlog, which in a way makes our planning in our supply chain easier, but in some ways poses other challenges of making sure we are delivering products to the right consumer, our customers at the right time.

Good afternoon. Great job on the quarterly execution, and congratulations to all on the executive appointments. Hock, we're at the very start of the 400 gig networking upgrade cycle with your hyperscale customers. It seems like telecom service providers are also starting to adopt the whitebox switching and routing model, which is good for your Tomahawk and Jericho chipsets, and you guys are also benefiting from the optical connectivity that goes along with your switching solutions. Beyond this quarter, do you see sustainability of the networking upgrade and spending cycle through next year? And then given the wafer and substrate constraints, are your lead times in networking expanding beyond six months now?

Thank you for your thoughtful question, Harlan. To respond to the first part, yes, our new product generation on the 400G platform is set to ramp up significantly in the upcoming fiscal year. We do not anticipate any slowdown in demand. You are right that service providers and operators are adopting merchant silicon in their routing platforms and networks, especially in core and edge deployments. The demand and success we are experiencing is reflected in the backlog and orders from service providers, particularly for our merchant silicon Jericho family, not just from hyper cloud providers. Our lead times remain below six months. Additionally, we have a strict policy that orders cannot be canceled, which all our customers and partners are aware of. We are witnessing real demand extending at least six months into the future, aligning closely with the second half of fiscal '21, just in time for the seasonal ramp of our next generation wireless products. Therefore, our visibility for '21 is significantly better than what we typically see at this early stage of a fiscal year.

Hi everyone. I appreciate you taking my questions. I wanted to ask about the wireless trajectory. Last quarter, due to the change in seasonality, you provided some insights, and you mentioned that this quarter might still show sequential growth. How should we interpret the seasonality, particularly regarding the May quarter compared to February? It seems that wireless in Q4 came in slightly lower than expected, and some of that has shifted into Q1. Considering these factors and the typical seasonal peak in Q1, could you provide some guidance similar to last quarter on what we might expect for the wireless trajectory heading into fiscal Q2?

Well, that's a tough question, and to begin with, we generally don't talk much about Q2. You're right in your observation regarding the wireless revenue profile, so we see that Q4 fiscal '20 becomes the first quarterly ramp of our wireless business compared to Q4 fiscal '19, which in typical cycles in the past should be the peak quarter of revenue. The quick ramp now for this current generation of phones in our wireless business will be out in Q1, which compares to Q1 of fiscal '20, that is the previous peak of the last generation. I also indicate that we expect a notable increase in our wireless revenue now, over 50% year-on-year. Now with regards to Q2 as you pointed out, things seem back to a more normalcy, and typically we would expect wireless to demonstrate seasonality, projecting it as the bottom quarter of an annual cycle.

Yes, good afternoon, Hock. Glad to see that you're sticking around. I guess I want to ask some of the questions around the management change and specifically Tom's new position. I'm just kind of curious what that might mean for the software infrastructure business longer term, and whether or not there is any sort of plan to potentially spin that business out. And I asked the question because clearly when you look at the core IP you have in your Silicon business around IO around acceleration and how important those IP blocks are, when you look at the sum of the part valuation of overall Broadcom, it just looks dirt cheap. You've doubled the operating margins in the software businesses since you acquired those companies and you've got great franchises in Silicon, which are trading at a big discount. Is there a belief that perhaps the best way to get value longer term for these businesses might be a spin, and is that part of the rationale behind Tom's new position?

I appreciate your speculation, but there is no plan in place. The software business, particularly in go-to-market strategies, is very intriguing for us as a company. Broadcom generates approximately $20 billion to $25 billion in revenue annually and operates as a technology provider to a diverse ecosystem. This includes addressing the needs of end-users, such as hypercloud services, service providers, and large enterprises. From this perspective, our software and infrastructure software are similar to the silicon solutions we offer. Ultimately, we cater to the same end-users, whether they are utilizing semiconductor hardware solutions, developer kits, or infrastructure software.

Hi, thanks for letting me ask the question and congrats to all the senior appointments. I guess this one could be for Hock, Tom or Kirsten, I want to talk about the capital allocation side versus a year-ago, you de-levered the balance sheet, pushed out the maturities locked in some good rates. So that doesn't seem to be an issue there. You're comfortable enough to raise your dividend significantly. So I wanted to hear what your thoughts are especially given the pandemics and what’s going on with the backlog being as large as it is, as far as how are you thinking about the other half of your capital, any sort of update given the environment? Or is it as simple as you're just going to focus on either giving it back with shareholder returns via buybacks or doing a deal?

Hey Ross, it's Tom, I'll take that one. I think it's very much back to business as usual. I think obviously 2020 we got into crisis mode earlier in the year. I think we focused a lot on pushing out maturities, we padded the balance sheet from a liquidity standpoint, which we continue to do. And the markets were very favorable. And we'll do all that. I think obviously, business also came back and performed quite well and as Hock has talked about, we've got a decent amount of visibility in the first half, and we'll see what happens in the second half. But it seems like this year is set up for a reasonable amount of success. And so I think with that in mind, we're comfortable with our investment-grade credit ratings, we have de-levered, we paid down $3 billion of debt in Q4. We're upping the dividend, as you mentioned, sticking to the policy of giving back about 50% of free cash flow. So that's going to leave us with some excess cash. And we always look at it as what are the right relative returns and what's best for shareholders. That usually means buying back stock or doing M&A. I think we'll certainly look at doing both.

Hi, I guess I wanted to follow up on John's question. So, in addition to the management changes, you're pretty much giving us a full segment P&L, which you've never done before. So I guess the question is why now? Is there some investor feedback on maybe that the segmentation will drive a better multiple? I mean, for sure the stock is very inexpensive, and it seems like some of the parts would be a better way to value it, but is there some feedback that's giving you driving you to sort of break out segment P&L?

Tim, you answered your own question perfectly. Yes, we're doing it because we feel that we should give more disclosures, more specifics of our various businesses, as you noticed, in addition to giving a full P&L to the extent there is because there's also some amount of allocation. But we tried to be very representative of our two large segments, Semiconductors and Infrastructure Software. You'll notice that within it, especially in semiconductors, we give you a lot more color and break down on what drives, which are the particular end-market applications in semiconductors, and the behavior and dynamics in each of those verticals. We found it is appropriate to give you more specifics, what's driving the overall revenue, and what has changed because as I also indicated in my last earnings call, we began this year with certain expectations, which had dramatically changed as we finished the year. I have expected semiconductors as an industry to recover from downturns of 2019, obviously and that 2020 will be a slow steady recovery, accelerating into the back-end. What we didn't expect is the recovery we saw in specific areas due to the pandemic and work from home environment. We see those businesses that are performing well, and it's important to give more disclosures to explain the overall revenue drivers.

Hi guys, thank you so much for squeezing me in. I had a follow-up question for Tom. Now that you'll be leading the software business going forward, where are the one or two top priorities for you in running that business?

Toshiya, there are so many questions. I can hardly recall the first one, but I'm excited about the strong team we have that is uniting the go-to-market and business units. This will enable us to scale and continue our growth, which we've already begun to experience. We've seen some initial success, but we still have much to learn. I believe this sets us up nicely, and I'm eager for what lies ahead. For any other follow-up questions, we can address those on the callback, but thank you very much.

Thank you, Operator. So, in closing, we did want to note that we'll be kicking off the presentations by our general managers at the J.P. Morgan Tech's Forum on Tuesday, January 12. Hock will be joined by Ram Velaga and Alexis Björlin from our Networking Division to present at that event. So, thank you. That will conclude our earnings call today. And Operator, you may end the call.