Broadcom Inc (AVGO) — Q3 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 Croft, President, Broadcom Software Group; and Charlie Kawwas, Chief Operating Officer. Broadcom also distributes a press release and financial tables after the market closed, describing our financial performance for the third quarter of the fiscal year 2021. If you did not receive a copy, you may obtain the information from the investor 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 remarks, Hock and Kirsten will be providing details of our third quarter of the fiscal year 2021 results, guidance for our fourth 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 recent filings with the SEC for information on the specific risk factor 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. I will now turn the call over to Hock.

Thank you, Ji, and thank you, everyone, for joining us today. In Q3, semiconductor solutions revenue grew 19% year-on-year to $5 billion. With infrastructure software revenue growing 10% year-on-year to $1.8 billion, consolidated net revenue was $6.8 billion or up 16% year-on-year. In Q3, demand continued to be strong from HyperCloud and service provider customers. Wireless continued to have a strong year-on-year comparison. And while our enterprise has been on a trajectory of recovery, we believe Q3 is still early in that cycle and that enterprise was down year-on-year. On the supply side, we continue to keep our lead times stable. With that as context, let me provide more color by end markets. Starting with networking. Networking revenue of $1.8 billion grew stronger than we had forecasted, up 19% year-on-year versus low double-digit growth and represented 36% of our semiconductor revenue. The better-than-expected growth was driven by routing from service providers in the expansion of 5G networks for backhaul, metro, and call, as well as major share gains in Internet Ethernet network interface controllers within data centers. While we experienced strong orders from OEMs, consistent with our recovering environment for enterprise spending, we believe the actual deployment of networking in the enterprise is still lagging from a year ago. Our shipments and revenue appropriately reflect this. In Q4, however, we expect a different set of demand dynamics. We see Cloud customers upgrading to our next-generation 800 gigabit-based Tomahawk 4 and Trident switchers. We're the first and only provider of 25.6 terabit switchers. And we are shipping 2 versions, 1 with 512 lanes at 50g and the 256 lanes at 100G. I would like to highlight that we are the only company today shipping 100 G. In data center switching, as in, service provider routing. We continue to lead next-generation product transitions, as our engineers continue to out-execute what's out there. And in Q4, against a very strong year-on-year comparison, we expect networking revenue growth to be below double-digit year-on-year. Next, our server storage connectivity business was $673 million in Q3, down 9% year-on-year in line with our guidance, and represented approximately 13% of semiconductor revenue. As you know, our products here supply mission-critical applications largely to enterprises, which as I said earlier, was in a state of recovery. That being said, we have seen a very strong booking trajectory from traditional enterprise customers within this segment. We expect such enterprise recovery in service storage and the same is happening in networking to be one of the drivers of growth in Q4 and into 2022. In this particular segment, customer transition to our next-generation NVMe connectivity at the server level funds this growth. The aggressive migration in the cloud to 18 terabyte hard disk drives will also provide a strong tailwind to demand for external storage connectivity products in this segment. In sharp contrast to the 9% decline in Q3, we forecast in Q4 server storage connectivity revenue to be up low double-digits percentage year-on-year. Moving onto broadband. Revenue of $910 million in Q3 grew 23% year-on-year and represented 18% of semiconductor revenue. This was primarily driven by the 2x growth in deployments of Wi-Fi 6 excess gateways, as well as double-digit growth in next-generation fiber and DOCSIS 3.1 cable modem deployments. For Q4, we continue to expect double-digit year-on-year revenue growth in broadband, which we have been seeing for the last few quarters. So, looking ahead, we see service providers like AT&T, British Telecom, and Deutsche Telekom deploying in increasing volumes next-generation last-mile fiber connectivity to homes in the U.S. and globally. These multiyear and multibillion-dollar investments by these operators attach to every one of these fiber nodes, unique Wi-Fi connectivity for the last 100 feet within the homes. And we lead the global transition to Wi-Fi 6 today. We expect our strong design-to-win momentum for Wi-Fi 6E as U.S. and European operators will sustain our market position into the next generation. Now, moving to wireless. Q3 revenue of $1.4 billion was up 35% year-on-year, in line with expectations, and represented 29% of the semiconductor revenue mix. In Q4, we expect wireless revenue to ramp approximately 33% sequentially in support of the launch of next-generation smartphones, and to be up 25% year-on-year. Finally, industrial revenue of $205 million in Q3 represented approximately 4% of Q3 semiconductor solutions revenue. Resales here grew what we consider an unsustainable 55% year-on-year driven by aggressive buying from OEMs in automotive, robotics, and renewable energy. As a result, inventory in our channels declined significantly to below 2 months. And turning to Q4, we do expect resales to come down to a more rational 20% year-on-year growth. In summary, Q3 semiconductor solutions revenue was up 19% year-on-year, and in Q4, we expect the momentum to continue and revenue growth to be up double-digits percentage year-on-year. Turning to software. In Q3, infrastructure software revenue of $1.8 billion grew 10% year-on-year and represented 26% of total revenue. Within this, Brocade grew 27% year-on-year, driven by the launch of new generation, Gen 7 Fiber Channel stem products. Excluding Brocade, Broadcom Software revenue grew 6% year-on-year. In dollar terms, bookings averaged 116% over expiring contracts, while in our call accounts, we averaged 129%. Over 9% of these bookings represented recurring subscription and maintenance revenues. Reflecting these renewals, we expect our infrastructure software revenue to be on track to grow around mid-single-digit percentage year-over-year, which is again, what we expect to see in Q4. So, in summary, combining a strongly growing semiconductor segment with our more stable software segment, total Q3 net revenue grew 16% year-on-year, and we expect this double-digit growth to sustain in Q4. Total revenue is projected to be $7.35 billion or up 14% year-on-year. With that, let me turn the call to Kirsten.

Thank you, Hock. Let me now provide additional detail on our financial performance. Revenue was $6.8 billion for the quarter, up 16% from a year ago. Gross margins were 75% of revenue in the quarter, and up approximately 85 basis points year-on-year. Operating expenses were $1.1 billion, flat year-on-year driven by lower SG&A and continued investment in R&D. Operating income for the quarter was $3.9 billion and was up 24% from a year ago. The operating margin was 58% of revenue, up approximately 360 basis points year-on-year. Adjusted EBITDA was $4.1 billion or 61% of revenue. This figure excludes $134 million of depreciation. Now a review of the P&L for our two segments. Revenue for our Semiconductor Solutions segment was $5 billion and represented 74% of total revenue in the quarter, which was up 19% year-on-year. Gross margins for our semiconductor solutions segment were approximately 70%, up 110 basis points year-on-year, driven primarily by favorable product mix and content growth as we deploy more next-generation products and broaden in networking. Operating expenses were $783 million in Q3, flat year-on-year. R&D was $693 million in Q3, up 1% year-on-year. Q3 operating margins increased to 54%, up 410 basis points year-on-year. While semiconductor revenue was up 19%, operating profit grew 29%. Moving to the P&L for our infrastructure software segment. Revenue for infrastructure software was $1.8 billion and represented 26% of revenue. This was up 10% year-on-year. Gross margins for infrastructure software were 90% in the quarter, up 125 basis points year-over-year. Operating expenses were $359 million in the quarter, up 1% year-over-year; R&D spending at $226 million is up 9% year-over-year, and SG&A of $133 million is down 11% year-over-year. The operating margin was 70% in Q3, up 305 basis points year-over-year, and operating profits grew 15%. Moving to cash flow, free cash flow in the third quarter was $3.4 billion, representing 51% of revenue. We spent $115 million on capital expenditures. Day sales outstanding were 30 days in the third quarter compared to 42 days a year ago. We ended the third quarter with an inventory of $1.2 billion, an increase of 156 or 16% from the end of the prior quarter in preparation to meet customer demand in Q4. We ended the third quarter with $11.1 billion of cash and $40.5 billion of total debt, of which $279 million is short-term. Turning to capital allocation, in the quarter, we paid stockholders $1.6 billion of cash dividends. We also paid $347 million in withholding taxes due to vesting of employee equity, resulting in the elimination of approximately 739,000 AVGO shares. We ended the quarter with 412 million outstanding common shares and 449 million diluted shares. Note that we expect the diluted share count to be 448 million in Q4. Our Board of Directors has approved a quarterly cash dividend on our common stock of $360 per share in Q4. Based on current business trends and conditions, and to reiterate what Hock has said, our guidance for the fourth quarter of fiscal 2021 is for consolidated revenues of $7.35 billion, and adjusted EBITDA of approximately 61% of projected revenue. That concludes my prepared remarks. Operator, please open up the call for questions.

Yeah. Good afternoon, guys. Thanks for letting me ask a question. Hock, I'm just kind of curious. You kind of did what you said you were going to do 90 days ago. But this is usually the part of the cycle, especially on the semi-business, where I would have expected more upside. And clearly, when you look across the sector, most companies are putting up an upside that you guys didn't see in the July quarter. So, I'm curious if you can help us better understand what happened. Do you think that this was mostly a supply issue? And given that inventory grew 15% sequentially in the quarter, to what extent do you think now that you kind of got that under control and going forward, you'll have a better supply environment to fulfill this demand.

Well, I mean, supply is always something that is very much an issue of constraint in this environment, as you well know. But the other side of the picture is we are really shipping as we have said, in previous calls several times. To put it directly, we are shipping to exactly, we believe to what demand requires. By that, I mean end-user and demand requirements. We are trying very hard not to overshoot in building pockets of excess inventory within our ecosystem. So, I think we're managing very much to what we see out there.

Great. Thank you.

Yeah. Hey, Hock. First of all, congratulations on solid results guidance. The question for you is, everybody's favorite foundry TSMC is talking about price increases. In some cases, they're substantial. Do you feel that you can pass us along and also at this point in time, companies are probably securing capacity for next year? Can you talk about your capacity, you know, your ability to get some extra capacity to be able to grow next year? Thank you.

Okay. Very interesting questions, Harsh. First and foremost, from outside, we try not to talk about customers specifically. And the same applies very much to strategic suppliers too. So, I wouldn't comment at all on what you alluded to here, but as far as our capacity for 2022, I think we have gotten a pretty good supply availability lineup for 2022, and we feel pretty okay about that. I won't say great but, in this environment, all things considered, we're feeling quite good. Thank you.

Hi guys, thanks for letting me ask a question. Hock, I want to touch on the enterprise business. You mentioned it a couple of different times when you were talking about both networking and your server storage connectivity segments. So, I guess a two-part question. 1, how much of your semiconductor business do you believe is enterprise exposed? And 2, when do you believe that will return to year-over-year growth? And is that a specific thing to Broadcom with your product cycles or is it just the end-markets returning to year-over-year growth at that time?

Okay. Traditionally, we define enterprise separately, particularly in the semiconductor segment. Our revenue can be analyzed across three distinct categories: cloud and service providers combined as one, consumer which relates to our wireless business, and what we refer to as traditional enterprise. We also consider telcos and service providers as part of the cloud category. The service storage market accounts for approximately half of our total semiconductor revenues. To address your question, I've mentioned in my remarks that we have witnessed a year-over-year increase in revenues within server storage, primarily driven by traditional enterprise, making up about 80% to 90% of this growth. This reflects positively on the performance of traditional enterprise, which, compared to the latest Q3, still shows a mid to high single-digit decline from last year. However, due to robust bookings we've experienced over the past three months, especially from large OEMs who integrate our products and sell to end-users, we expect enterprise growth to reach double digits year-on-year in Q4. Thus, we anticipate reaching a point of crossover sometime in Q4.

Thank you.

Thanks a lot. Following up on that same question. Last quarter you were predicting, or you thought that the excellent growth you've seen in Cloud server providers and telcos might lighten up next year as the day, just that as enterprise started to grow and there'd be kind of a mix shift there, but it sounds like that isn't lining up and enterprise is coming back a bit sooner. Did you think any differently now about telcos and service providers in the Cloud, will that last longer? Do you still expect to maybe lighten up in 2022? And how long do you expect the enterprise has been down for quite a while now, the enterprise upward trend to last? I'm just trying to get a feeling with the profile of demand looks like in your core business next year. Thanks.

Certainly, I'll provide that. Currently, we anticipate several developments for 2022. Service providers and telcos are performing strongly and seem to maintain their elevated position rather than declining. For the enterprise segment, we continue to observe a positive trend in demand and spending, which we expect will enhance even further in the upcoming quarter and beyond. I believe that enterprise spending will be a key driver for our semiconductor business in 2022, with notable contributions from sectors like networking and server storage. Both areas are demonstrating substantial growth as we move into 2022. To reiterate, we see telcos and service providers consistently maintaining strong levels.

Does that imply you expect the Cloud to lighten up a bit then too, because you just called out service providers and telcos, but your kind of did talk about it?

No, I mention service providers sometimes when referring to Cloud as well. We talk about Cloud alongside service providers and telcos.

Hi guys, thanks for taking my question. I wanted to ask you about capital allocation. Obviously, well half of the cash flow goes to the dividend, the other half goes, I mean, ideally to M&A or buybacks. And it's been a while since obviously you executed M&A and we're kind of getting towards the end of the year. At what point do you kind of make the decision to give up on M&A this year and start buying back stock or do you save the cash for a potential deal next year? Just how do we think about your mindset around the M&A environment versus just using the cash for buybacks, and then maybe starting to cycle over again at some point as we get into the next year?

It's not the first time I've been asked this question, as I've received it in the last quarter and the one before that. I've stated my position on this and remain firm in it. As you know, we will continue until the end of this fiscal year, which is in October or November. At that time, we will decide whether to use the cash for acquisitions or to buy back our shares.

Does that mean you would have to have a deal in mind in October, November, or could the call be to save the cash for something in the future? Or like if you don't have a deal on the books in October, November, do we see a buyback?

More probably blade that was simple ways as far as saying that as you correctly say, we're accumulating cash at a fairly dramatic rate. And so, by the end of October, our fiscal year, we'll probably see the cash net of dividends, our cash pool to be up to close to $13 billion, which is something like 678 billion above what we would otherwise like to carry on our books. So, we have to make a decision at that point.

Good afternoon. Congratulations on the strong quarterly execution and results. Strong free cash flow generation in Q3, and you provided the EBITDA profile for Q4. If I consider normalized assumptions on cash interest payments, cash taxes, and CapEx, it seems that the team is on track to generate approximately $13.7 billion in free cash flow this fiscal year. This could translate into an increase in dividends to at least $16.70, possibly a bit more, if the team continues to return 50% of the free cash flow. My question is about Q4: are there any one-time cash events, timing-related dynamics, CapEx increases, or tax-related events that we should take into account, or is my free cash flow and dividend calculation approximately accurate? Additionally, the team has a substantial logistics, warehousing, and supplier footprint in Malaysia. Given the significant increase in COVID-19 cases there, is the team facing potential facility closures, or how is the team managing this situation?

I'll take that first question that you asked and then I'll have Hock take the second one. Essentially, our policy isn't changing, we're going to return 50% of our free cash flows to our stockholders, and I would say your math's pretty good.

You're spot on, on your math. Almost. Right. In terms of concern that you expressed about the resurgence of COVID-19 infections in Malaysia where we have a large supply chain team located. You're right. It's challenging, but we're managing very well, I think, our teams there. I would say practically 99% of our people in Malaysia have been vaccinated. We made arrangements with the Malaysian government and ensured that this was done. And this has been done, so we are able to manage through this resurgence in Malaysia. And we will continue to keep our eye very closely on conditions over there. But for now, I think we are okay.

Thanks for taking my question. Actually, I just wanted to clarify something and then have the question. On the clarification, I think, Hock, you mentioned you're shipping to demand? Does it mean you're not seeing any supply shortages? Then that would be very different than what we are hearing from every other semiconductor Company. So just wanted to make sure I have the right interpretation. And then my question is just kind of the long-term growth rate for Broadcom? In the past year, I mentioned this mid-single-digit growth rate. I understand that this year's compares make it easier to grow faster than that. But as you look at Broadcom over the next handful of years, do you think you are in a situation to grow better than the mid-single-digit growth rate? What is missing to make you upgrade that mid-single-digit growth rate, the conceptual forecast that you have provided in the past?

Let me address the first part of the question first, as it's important and ties into John Pitzer's inquiry about why we're not shipping at high volumes and if we're supply-constrained. We're focused on optimizing every wafer in this environment, and I believe we're doing that effectively, which is reflected in our strong margins. Our supply chain management is careful; we monitor and manage demand as we define it, meaning we emphasize the end-users who need our products. In the industrial segment during Q3, we saw distributor resales where end-users went to our distributors and cleared out our inventory, leading to a reported resale growth of 55%. However, that's not indicative of real demand; rather, it reflects a buildup of inventory due to panic buying. This behavior is evident across the semiconductor market unless key suppliers are involved. We maintain strict discipline in managing our supply to align with true demand, rather than responding to OEMs or end-users who are creating buffer stocks everywhere. This proactive approach differentiates us from many other semiconductor companies, which may be why John Pitzer observes that others are reporting bigger numbers. We could increase our numbers as well, but that would lead to building up inventory inappropriately, and we need all of our wafers in this environment to ensure our strategic customers can access what they need for their launches and programs.

And on the long-term growth rate?

I believe that the recent events, particularly COVID-19, have significantly altered work habits and could lead to an increase in technology consumption, including semiconductor chips, in the long term. There has certainly been a rapid adoption of specific technologies due to the lockdown, which has driven strong demand for semiconductor products over the past year. We have seen year-on-year growth in demand reach the mid to high double digits, which is quite strong compared to my model predicting mid-single-digit long-term growth for semiconductors. However, I don't think this surge in consumption indicates a permanent change in people's technology usage. Once we return to a more normal lifestyle—perhaps not this year, but next year or the year after—I anticipate that this heightened consumption will stabilize. Over the next five to ten years, I find it challenging to envision why semiconductor consumption would exceed current levels. The industry is relatively mature, although still evolving and changing, which makes it interesting. I may be mistaken, but I believe we will revert to a norm in that timeframe. The question then becomes whether that norm will be in the high single digits instead of mid-single digits, and you may have a point there. Currently, we are experiencing a year-on-year demand increase of 15% to 20% for our semiconductor chips, and we have a diverse presence across various end markets. While certain areas may indeed grow faster than the mid-single digits, I believe our broad market representation will lead us back to the established norm, and it is possible that this norm could exceed mid-single digits, as I have mentioned before.

Thank you.

Hey, good afternoon. Thanks for taking the question and I want to ask about broadband, been running kind of in the '20s, year-over-year. You said up double-digits for Q4. I think last year is easy to compare, so I just want to know how literally to take that. I know you said maybe over time that would be the one segment that could moderate. It's enough you're signaling anything for October.

Broadband is a complex issue to address. It's challenging due to two key factors that I mentioned earlier. Wi-Fi, particularly Wi-Fi 6, plays a significant role as service providers, including telecom and cable operators, are utilizing it to connect households worldwide. We have captured a substantial share of that market, and this trend is continuing with the emergence of next-generation Wi-Fi 6E. Fiber also plays a crucial role in broadband, as many large telecom companies in Europe and the U.S. are investing heavily in deploying fiber to homes, partly due to political pressure to enhance household connectivity. For example, British Telecom has announced plans over the next 5-6 years to connect over 20 million households, similar initiatives are being undertaken by Deutsche Telekom and AT&T in the U.S., each committing billions to these multiyear projects. At the end of the fiber nodes, there is wireless connectivity that covers the last leg into homes. This indicates that the fiber market might not be the slow-growth sector it was once perceived to be. We are seeing significant programs from these operators, particularly in the U.S. and Europe, aimed at expanding broadband through fiber, which is an effective and cost-efficient approach to household connectivity, in tandem with the rollout of 5G networks. Additionally, the competitive landscape for market share is evolving, shifting from China to include Europe and the U.S., with fewer technology players involved, especially in light of recent political developments.

Good afternoon. Thank you very much. Hock, I noticed in your prepared remarks that you were more specific about some of the leadership positions Broadcom holds in various advanced technologies. You seemed to emphasize this more than you have in the past. It’s an advantage the Company has in your own switching and routing products, as well as being the preferred ASIC provider for several hyperscale companies. I wonder if you mentioned this deliberately. Is there a competitive shift happening given the scale of your R&D? Do you feel that your lead is expanding, shrinking, or remaining the same? Any update would be appreciated. Thank you.

That's very insightful of you. The only reason I highlighted this is that it's accurate and will continue to be for many years. I want to emphasize that we are likely the preferred vendor for specialized silicon engines to handle specialized workloads, particularly in HyperCloud as you've mentioned. We are significantly ahead in these areas due to the reasons you outlined. We possess the scale and the necessary intellectual property and capabilities to produce chips for multiple customers willing to push the boundaries on specialized offloads, including computing engines, video transcoding, machine learning, smart devices, and various other specialized engines and security solutions we've implemented across several Cloud providers. This serves as a reinforcement that we remain the leader in this space.

Thank you, Operator. In closing, please note that Hock Tan will be presenting at the Deutsche Bank Technology Conference on Thursday, September 9th, and the Citi Technology Conference on Tuesday, September 14. Kirsten Spears will participate in the Piper Sandler Tech Conference on September 13. We will also be hosting a Broadcom Software investor meeting on Tuesday, November 9, in New York. Tom Krause from Broadcom Software Group will be leading the events, and senior leadership from our software business will present. We will be sending invitations to analysts and investors in the coming week. That will conclude our earnings call today. Thank you all for joining. Operator, you may end the call.