Broadcom Inc (AVGO) — Q1 2021 Earnings Call Transcript

Thank you, operator, and good afternoon, everyone. Joining me on today's call are Hock Tan, President and CEO; Kirsten Spears, Chief Financial Officer; Tom Krause, President of the Infrastructure Software Group; and Charlie Kawwas, Chief Operating Officer. Broadcom also distributed a press release and financial tables after the market closed, outlining our financial performance for the first quarter of fiscal year 2021. If you did not receive a copy, you can find the information in 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 and Kirsten will share details about our first quarter fiscal year 2021 results, guidance for our second quarter, and insights on the business environment. We will take questions after the prepared comments. Please refer to our press release today and our recent filings with the SEC for information on 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 today will primarily refer to our non-GAAP financial results. I'll now turn the call over to Hock.

Thank you, Ji, and thank you, everyone, for joining us today. Well, we delivered net revenue of $6.7 billion, up 14% year-on-year. Semiconductor Solutions revenue was $4.9 billion, increasing 17% year-on-year. Infrastructure Software revenue was $1.7 billion, up 5% year-on-year. Let me turn first to Semiconductor Solutions. But before I get into the numbers, perhaps it would be very constructive for me to give you my perspective on the situation today. And in fact, what has actually evolved over the past nine months. You may recall in our earnings call Q2 fiscal 2020, around the middle of last year, that we highlighted supply chain challenges. Since then, we have started extending lead times across our product portfolio, which we stretched further over the past nine months as we saw demand within end markets continue to increase. So fast forward to today, we see customers accelerating their bookings for early deliveries and attempting to build buffers, creating the demand-supply imbalance you all hear out there. In anticipation of this phenomenon, we put in place in May 2020 a very rigorous, disciplined process of carefully reviewing our backlog, identifying real end-user demand, and aligning our supply chain to more closely match end-user consumption. Of course, not all end markets are behaving the same way, but we believe we have done a very good job of balancing demand and supply in our end markets. And what I'm reporting today does reasonably reflect what's been consumed by our end-users. With that, let me get into the numbers. In Semiconductors, we grew 17% year-on-year organically. Starting with wireless, we hit the seasonal peak in Q1 where wireless was up 52% year-on-year and reached 40% of semiconductor revenue mix. This sharp increase was largely due to a higher content – FBAR content was up, and we shipped in high volume Wi-Fi 6 and Wi-Fi 6E, the next generation of Wi-Fi 6. As expected, Q2 wireless revenue will now show a typical seasonal decline sequentially even as anticipated revenues will be up 30% to 40% year-on-year. And as we look into the second half of the year, we're planning for a typical revenue ramp in this space and structuring our in-house FBAR fab capacity appropriately. These should result in sustaining the year-on-year growth trend we now see in Q2 through the second half of the year. Moving on, networking represented approximately 29% of our Semiconductor Solution revenue in the quarter and grew 15% year-on-year. Demand is strong, driven largely by data center spend in the cloud and global telcos, who continue to upgrade their infrastructure and network. Sustainability of this strength is evidenced by bookings as they jumped 80% year-on-year and 62% sequentially. Demand for switch and routing platforms, both current and next generation, is robust. But as anticipated, our AI TPU business was seasonally down this quarter. Moving on to Q2, we expect networking to be up sequentially and continue the trend of being up year-on-year, driven by continued strength we see from cloud and telcos, partially offset by continued weakness in enterprise. Turning to broadband, which represented approximately 15% of Semiconductor Solutions, revenue was up 8% year-on-year, driven by the work-from-home environment. Multiple telcos, both in Europe and the U.S continue to roll out PON and cable DOCSIS. Embedded in these wireline gateways are our next-generation Wi-Fi 6 access points. Softness in enterprise was more than offset by strong demand from retail home routers, even as telcos continue to spend. Looking at Q2, we are enabling the launch of new Wi-Fi 6 enabled platforms with higher value content for North American and European telcos. As a result, we do see the demand accelerating and consumption increasing, and we expect to generate double-digit year-on-year revenue growth in broadband. Server storage connectivity represented approximately 12% of Q1 semiconductor revenue. This segment is largely driven by enterprise demand as we know, and not surprisingly, server storage revenue was down 22% year-on-year, reflecting continued softness in end-user demand as well as OEMs, original equipment manufacturers, depleting their inventory in this space. While bookings have improved, these are largely for demand in the second half. Accordingly, we expect revenue in Q2 to continue to be down year-on-year by a double-digit percentage. However, we do expect some recovery based on our bookings received in the second half. Finally, industrial represented approximately 4% of Q1 Semiconductor Solution revenue. Resales grew 13% year-on-year in Q1, driven by a recovery of multiple economic sectors in China. Turning to Q2, we expect resales to grow at roughly the same level as we see recovery now occurring in Japan and Europe. Inventory in the channel for us continues to deplete, and we may have to increase shipments and revenues to replenish channel inventory this quarter. In summary, Semiconductor Solution revenue segment revenue was up 17% year-on-year in Q1. For Q2, we expect this year-over-year percentage revenue growth to continue at a similar amount, despite a seasonal decline in wireless. The way it looks now is a relatively strong trend appears to be sustaining through most of 2021. However, in our view, this very high and unusual secular growth rate merely highlights an accelerated adoption of our connectivity platforms during this pandemic. Turning to our other segment, software. Q1 2021 was our first quarter that on a year-on-year basis provides an organic comparison following the Symantec acquisition. In Q1, infrastructure software revenue growth was 5% year-on-year. In dollar terms, bookings averaged 122% over expiring contracts, while core accounts averaged 137%. Now over 90% of these bookings represented recurring subscription and maintenance. Our strategy of focusing on core accounts continues to perform well as we cross-sell our portfolio of software. In other words, our software portfolio continues to perform as we have planned and is on track with our long-term financial model for organic software revenue growth of around mid single-digit percentage year-over-year. That's something we expect to continue to see in Q2. So, in summary, our Q1 consolidated net revenue grew 14% year-on-year. We expect a similar growth trajectory in Q2, which could bring revenue to $6.5 billion or a 13% year-on-year growth. With that, I'll now turn the call over to Kirsten.

Thank you, Hock. Let me now provide additional detail on our financial performance. Net revenue was a record $6.7 billion for the quarter, up 14% from a year ago. Gross margins were 73% of revenue in the quarter, up approximately 30 basis points year-on-year. Operating expenses were $1.1 billion, down 8% year-on-year, reflective of the full benefit of the completed Symantec integration. Operating income from continuing operations for the quarter was $3.8 billion and is up 23% from a year ago. Operating margin was 57% of revenue, up 420 basis points year-on-year. Adjusted EBITDA was $3.9 billion or 59% of revenue. This figure excludes $138 million of depreciation. Now a review of the P&L for our two segments. Revenue for Semiconductor Solutions was $4.9 billion and represented 74% of total revenue in the quarter. This was up 17% year-on-year. Gross margins for Semiconductor Solutions were approximately 67% in the quarter, up 20 basis points year-on-year, notwithstanding the higher mix of lower-margin wireless revenue. Operating expenses were $750 million in Q1, down 3% year-on-year as we invested in R&D and streamlined SG&A. Because of this, operating margins increased to 52% in Q1, up 350 basis points year-on-year. So while semiconductor revenue was up 17%, operating profit grew 25% all organically. Moving to the P&L for our infrastructure software segment. Revenue for infrastructure software was $1.7 billion and represented 26% of revenue. This was up 5% year-on-year. Gross margins for infrastructure software were 90% in the quarter, up 190 basis points year-over-year. Operating expenses were $346 million in the quarter, down 18% year-on-year as we've completed the integration of Symantec. Operating profit was up 17% year-on-year on top line growth of 5%. Operating margin was 70% in Q1, up 740 basis points year-over-year. Moving to cash flow. Free cash flow in the first quarter was approximately $3 billion, representing 45% of revenue. This is up 35% year-over-year as we carefully manage working capital. Day sales outstanding were 35 days in the first quarter compared to 57 days a year ago. We ended the quarter with inventory of $952 million, a decrease of $51 million or 5% from the end of the prior quarter. We should also note that in Q1, we spent $114 million on capital expenditures. On the financing front, we extended our weighted average debt maturity to approximately 9 years from 6 by issuing new notes that we used to refinance and redeem existing debt. Our weighted average coupon increased about 23 basis points to 3.8%. We ended the quarter with $9.6 billion of cash and $41.9 billion of debt, of which $843 million is short term. Turning to capital allocation. In the quarter, we paid our common stockholders $1.5 billion of cash dividends. We also paid $225 million in withholding taxes due on the vesting of employee equity, resulting in the elimination of approximately 521,000 AVGO shares. We ended the quarter with $408 million outstanding common shares and $450 million diluted shares. Note that we expect the diluted share count to be $450 million in Q2. Based on current business trends and conditions, our guidance for the second quarter of fiscal '21 is for consolidated net revenues of $6.5 billion and adjusted EBITDA of approximately 59% of projected revenue. That concludes my prepared remarks. Operator, please open up the call for questions.

Hi, guys. Thanks for letting me ask the question. Hock, some good color on the supply side of the equation and a little bit about your lead times extending. I wanted to dive a little bit into that. Last quarter, you talked about a backlog? I think the number was $14 billion. Can you talk a little bit about the composition of your backlog today? How it is on an absolute level and the sustainability of it as investors are wondering if this demand is just too good to be sustainable? And what does it mean to excess bookings, double ordering that sort of inventory digestion that will inevitably follow thereafter?

That's an interesting and timely question. As I mentioned, we began this process almost nine months ago due to strong demand. We started considering how to maximize our supply chain capacity, thoroughly reviewing our backlog. Our backlog follows strict, non-cancelable terms for our customers, which remain in effect. Therefore, we don’t see double bookings as an issue. As we extend our lead times, customers are naturally scheduling delivery dates further out, which makes sense. This helps us align customer consumption with our supply effectively. While we always aim for improvement, we have a sound process that ensures customers receive their products when needed. We believe we are managing the balance between supply and demand well. To reiterate, our year-on-year revenue in Q1 increased by 17%, and bookings rose by 63%, demonstrating significant demand with customers scheduling far in advance. We're nearly 90% booked for 2021, which gives us confidence in the sustainability of this demand since cancellations aren't an option. Regarding your question about whether our backlog has increased as we enter Q2, the answer is yes, it has significantly, especially as we see lead times extend further. The strength of our current offerings and next-generation products, which are set to launch, is validated by our backlog, with many customers willing to schedule deliveries throughout 2021.

Good afternoon. Thanks for taking my question. Hock, the biggest concern by investors right now is your ability to drive growth in the seasonally stronger second half of your fiscal year, your July and October quarters, when you start to ramp into your flagship smartphone customers. If I just apply normal seasonal trends in wireless, combined with, let's say, sustained networking strength and, as you mentioned, recovery and storage, that would get me revenues in the second half in that sort of $6.77 billion range. And now I'm not asking you to endorse those numbers, but I guess the question is, from a supply chain perspective, has the team secured enough capacity to drive higher revenues in the July and October quarters, if your backlog supported that profile?

If you are really asking me to guide you, I'm not guiding you. But I do understand your question. In my prepared remarks just earlier, you can see where we see ourselves planning and the trend going. I've also specifically mentioned where we are manufacturing, like FBAR in-house, which is a big part of the upcycle in the seasonal upcycle in the back half on the wireless side. We have put in place the capacity to handle it. The simple answer to your question is, yes, we have done a decent job of being able to meet the critical needs of all our customers.

Thanks for taking my question. Hock, you mentioned you expected this 30%, 40% kind of year-on-year growth rates in wireless to sustain in the back half. I was hoping if you could give us some color on what kind of content growth you are expecting this year. And then looking forward, how much does Broadcom benefit from all these C-band spectrum auctions that were conducted recently? I assume that's more of an outer year benefit.

Yes, on the latter part, it is an outer year. This thing doesn’t get implemented so fast. As for formal part of your question, I can’t answer that for obvious reasons. It's too early. We will tell you about it when the time is appropriate. Thank you.

Yes, thanks for letting me ask the question. Hock, I just want to get back to the supply-demand imbalance. You did a very good job kind of explaining how you guys are trying to call your backlog. I'm curious, as you look out over the next couple of quarters, when do you think supply will catch up to demand enough, such that your customers don't feel obligated to have to build that cushion?

Another way of answering that question, John, I think is when do you see lead time reducing. Maybe not reducing and perhaps normalizing, that’s probably the other way of looking at that equation. Right now, I don't know the answer to that. What we do know is we have extended lead time today, and we've been extending the lead time over the past several months, as I indicated. We have a fairly extended lead time today and we're getting the bookings from the customer. When the bookings disappear is probably when you know you're headed to a situation of demand starting to decrease. We have not reached that point yet, far from it at this point.

Hi, guys. Thanks for taking my question. So Hock, you’re saying that you're stretching out lead times. I get it, but I think before you told us the lead times were 6 months. So if you're stretching them out, where are they actually sitting today? And how does that maybe vary by end market? And I guess to that end, you said you're kind of convinced that what you’re shipping now sort of represents end-user consumption. How do you actually have any visibility into that? And do you think the users, I mean, are the products actually going into end products? How do you know the users aren’t stockpiling them and ordering them while they can? How do you have any visibility into what they’re doing with them?

That's an excellent question. It gets to the heart of our recent efforts. I've never worked harder because, first of all, we offer a variety of products to numerous customers. It’s important to remember our established business model, which centers on providing technology leadership across various sectors, primarily in IT connectivity. We collaborate with leading customers globally, understanding their consumption patterns. Our focus is on direct end-user demand, not on intermediaries like distributors. For our top customers, we bypass distributors entirely. We also monitor original equipment manufacturers because their sales and the end demand for their products are crucial. In some areas, particularly server storage, and to a lesser degree in networking and broadband, we can differentiate between inventory depletion at manufacturers and actual usage by end users within the same quarter as shipping. We closely track this information. It's straightforward in terms of our revenues. In semiconductors, a significant portion of our revenue, about 75%, comes from just over 100 customers globally, and we can keep a close eye on that.

I appreciate the insight on the software bookings in relation to revenue. Now that you have had Symantec for a year and CA for a couple of years, could you discuss your confidence in the growth rates over the long term? I know you mentioned the 90% recurring revenue, which reflects how the transition is progressing with global large accounts.

Yes. As I mentioned in my prepared remarks regarding some of the key metrics we monitor, we are very optimistic about those two. We believe that progress is aligning with our expectations for both the business and financial model, which centers on focusing on core customers and enhancing our offerings for them across our portfolio. The metrics we've presented demonstrate growth. For non-core customers, while there is some manageable attrition, it is counterbalanced by improvements in the core. We anticipate achieving stabilization at mid-single digits consistently. We've maintained this performance level over the past two years, providing a clear outlook. Additionally, it's worth mentioning that nearly all of our customers are enterprises, even in the current environment. The differing demands and behaviors of enterprises, particularly in semiconductors, contrast with telcos, broadband, and public cloud during this pandemic and work-from-home scenario. We don't observe the same trend in our infrastructure software, as these products are essential for large enterprises' business processes, leading to increased consumption of our offerings rather than a decrease.

Hi. Thanks a lot. I guess, I also had a question on the supply-demand. Hock, orders obviously were up quite a bit in fiscal Q1, Q-on-Q, given that revenue was up in backlog. I think you said was up significantly. As you look into fiscal Q2, wireless orders are obviously going to come down a lot. So I'm wondering if orders in the other parts of the business are strong enough such that total orders will be up in fiscal Q2 again. Thanks.

Tim, when you say orders, and I hear you say orders, let me say, the orders, as we ramp up to this current generation of phones for a large North American customer, bookings started ramping up as early as Q3, really shot up in Q4 and started declining late Q4 and Q1. Bookings were already declining. When I indicated Q1 bookings year-on-year improvement of 80% and what I'm also saying is that is netting out a decline in bookings of our wireless in a fairly substantial manner as you would expect seasonally. So the answer is, yes. What we are seeing, what I'm reflecting out to you guys, those bookings that I showed in Q1, which is fairly strong, reflects declining bookings in wireless as we all expect seasonally at that time frame.

Thanks so much for taking the question. Hock, I wanted to ask about capital allocation. The dividend component is pretty predictable, but outside of the dividend, how are you thinking about paying down debt, buying back stock, and M&A in software? The markets are clearly very volatile right now, but how are you thinking about those three buckets on a relative basis? Thank you.

That’s a very interesting question. I was wondering when one of you would bring it up, and here we are. You’re correct, we are accumulating cash, and Kirsten mentioned it. In the first quarter, we generated $3 billion of cash. This is also the time when we distribute bonuses to our employees. If I normalize that, it amounts to about $3.5 billion a quarter in free cash flow. So it's building—almost half goes to dividends, which is already determined. The other half we are currently directing into a growing cash portfolio. Our business model and long-term strategy is focused on acquiring and expanding our portfolio to enhance our earnings stream for shareholders. We take that quite seriously and continue to evaluate it. If we haven't made an acquisition by the end of this fiscal year, we will closely consider our other options. One option is to pay down debt, which could happen even before then. Interest rates are low, funding is readily available, and we maintain a strong investment grade. The other alternative is share buybacks. All these options remain on the table.

Hey, good afternoon. Thanks for taking my question. Hock, I was just curious a little bit more on the wireless. We don't have the right compares year-over-year. So maybe if you just give us a little color as to what you're expecting. I just don't know what that 30% to 40% year-over-year really kind of compares to. So maybe just some color as to what you're seeing from that wireless channel versus normal seasonal patterns that would help us kind of dial in as to what you're really saying for April.

Well, as I indicated in my prepared remarks when it comes to wireless, this is for 2021. Don’t forget there is some timing adjustment by Q2, Blayne, in the sense that what used to be a big quarter in our wireless seasonality of fiscal Q4, in this recent generation, the peak quarter, as I indicated, begins in Q1 of '21. So obviously things roll down, perhaps somewhat slower. Because we are also assuming, as it rolls down slower in the course of fiscal '21, that we have to assume, for lack of knowing better, we might be back to a normal seasonal cadence of wireless launch and assume that we will be back to that normal cadence. So '21 might look kind of compressed when you think in terms of revenue and availability of a market for us to address. Then couple that with a content increase between '20 and '21, you therefore could understand why I indicated that for the rest of '21, it begins to look like a fairly significant 30% to 40% increase on a year-on-year basis as we run through the remaining quarters of '21.

Yes, good afternoon. Thank you for taking the question. I guess I wanted to dig a little into your EBITDA margin guide. It would suggest that either gross margins are flat, which would not seem likely given the fall off in wireless, or optics is moving higher. Can you kind of walk through the moving parts there? And as part of that, can you help us understand how to model gross margins and OpEx through the remainder of the fiscal year? Thank you.

So in Q1, we said that from year-over-year, gross margins were up 30 basis points, and that’s largely because of wireless. When you look at Q2, we will have less wireless revenues in the margin mix. Therefore, look back at Q4; that’s how I would model Q2. As you look at margins for the rest of the year, it would be similar to Q2. Look back at Q4 and then consider the fact that we will have probably more normal seasonality on wireless towards the second half.

Yes. Hey, thank you. Hey, guys, congratulations. Solid numbers. Hock, I had a question for you. I’m trying to wrap my head around some stunning numbers you threw out for networking, 80% increase in bookings, some 62% odd sequential increase. I appreciate the process of identifying real demand. So with that, is there something going on in bookings that is specific to your end markets or your product set that is driving it? Could you just highlight what is going on there?

Yes, that's a great question. I've been hinting at it in a roundabout way, so let me be direct. Our products are essential for our customers, particularly in broadband and networking. They're focused on expanding broadband and enhancing their networks. The demand for hosting from public cloud services, especially in this work-from-home era influenced by social media and online retail, is forcing all cloud providers to scale their data centers. They need to purchase our products, whether from our current lineup or the upcoming next generation. When we extend our lead times, customers see these orders as non-cancelable commitments. They question if they will still require the products in 6 or 9 months. They definitely need them and place their orders. The way we are stretching lead times is a testament to the strength of our product lineup and its critical importance to our users. I'm seeing customers booking what they require for 8 months out, as well as for shorter periods ahead. This behavior suggests that they genuinely believe they depend on our products to support their operations. What I'm conveying is that this change in lead time is a sign of the necessity for our products, and it helps us align our supply chain capabilities with demand. While it might be seen as overly simplistic, it's about managing expectations with our customers and maintaining a rational approach. If I were to ship out everything in my backlog today, they would take it all, as they're prepared for it. Knowing they can receive it in 6 months makes them willing to wait, and they reserve capacity by ordering in advance. This structured approach showcases the true underlying demand, which we intend to communicate effectively.

Thank you, operator. In closing, please note that Broadcom and Morgan Stanley will be hosting a presentation on our broadband business on Monday, April 12 after market close. Hock will be joined by Rich Nelson and Greg Fisher, General Managers of our broadband businesses. That will conclude our earnings call today. Thank you all for joining. Operator, you may end the call.