Skyworks Solutions Inc (SWKS) — Q3 2018 Earnings Call Transcript

Thank you, Kieran. Good afternoon, everyone, and welcome to Skyworks' third fiscal quarter 2018 conference call. With me on the call today are Liam Griffin, our President and Chief Executive Officer; and Kris Sennesael, our Chief Financial Officer. Before we begin, I would like to remind everyone that our discussion will include statements relating to future results and expectations that are or may be considered forward-looking statements. Please refer to our earnings press release and recent SEC filings, including our Annual Report on Form 10-K for information on certain risks that could cause actual outcomes to differ materially and adversely from any forward-looking statements made today. In addition, the results and guidance we will discuss include non-GAAP financial measures consistent with our past practice. Please refer to our press release within the Investor Relations section of our company website for a complete reconciliation to GAAP. With that, I'll turn the call to Liam.

Thanks, Mitch, and welcome everyone. The Skyworks team produced solid results once again in Q3. We generated a revenue of $894 million above consensus estimates. We expanded gross margin to 50.9%, up 20 basis points both sequentially and year-over-year. We delivered record Q3 earnings per share of $1.64, $0.05 better than our guidance. And finally, we continue to deploy our cash to create shareholder value, returning nearly $300 million during the quarter through share repurchases and dividends. From a market perspective, we are entering the seasonally strong second half while on track for another year of record financial performance. Based on our Q4 outlook, we will end the fiscal year with mid-single-digit revenue growth, greater than a 10% EPS increase and record cash returns. This despite a challenging market backdrop and a government-imposed trade ban on a sizable Chinese customer. Our confidence is underpinned by our product expansion and reach, expanding premier mobile and broad market accounts. For example, during the quarter, we commenced production of access solutions for Cisco, capturing content and Linksys' new dual-band mesh networks, ramped connectivity engines for Amazon’s 4K Fire TV, a leading voice-enabled streaming media platform. We partnered with Sierra Wireless on LTE CAT-12 data cards for M2M applications, deployed networking solutions supporting AT&T DirecTV gateway, extended our footprint across Nest home automation platforms, enabled LTE telematics at TM and BMW, and we introduced high precision GPS functionality, improving ride-sharing, mobile payment, and fleet management services. We also secured strategic flagship wins at Huawei, Samsung, Oppo, Vivo, LG, and Nokia. In our infrastructure markets, we powered massive MIMO solutions for a leading European base station supplier. In summary, we continue to expand the aperture of our design win pipeline spanning mobile, IoT, and a broadening set of diverse end markets. With IoT, the rapid proliferation of volumes represents a significant growth opportunity for Skyworks. Ericsson, for example, estimates that there will be 29 billion connected IoT devices by 2022. Meanwhile, 5G is upon us; dramatically higher speeds and lower latency enabled by 5G will catalyze a wide range of use cases, from the connected battery to the autonomous car to artificial intelligence. In order to make the leap to 5G, system architectures will require significantly more powerful connectivity engines to ensure performance hurdles are overcome. Skyworks is leveraging our deep systems knowledge, strategic partnerships, and formidable investments to accelerate the deployment of 5G with our Sky5 platform providing end-to-end performance across this critically important new spectrum. To that end, we reached key milestones this past quarter, including the launch of our Sky5 antenna tuning portfolio. Our newest 5G solutions deliver enhanced bandwidth coverage from 60 megahertz to 6 gigahertz. This is an enormous and incremental source of content growth for Skyworks as the number of antennas increased substantially across 5G engines. In addition, last quarter we successfully demonstrated our proprietary fully integrated Sky5 sub-6 gigahertz engines supporting new 5G and our radios across frequency bands and n77, n78, and n79. Quite simply, Sky5 is enabling new 5G networks and facilitating ubiquitous wireless connectivity for both people and things. I will now turn the call over to Kris for discussion of last quarter’s performance and our financial outlook.

Thanks, Liam. Revenue for the third fiscal quarter of 2018 was $894 million, exceeding consensus estimates. Gross profit was $455 million with gross margin at 50.9%, up 20 basis points sequentially as well as year-over-year. Third quarter operating expenses were down sequentially to $130 million. As a result, we generated $325 million of operating income translating into an operating margin of 36.3%. Our tax rate was 8.9% in the quarter. Net income was $300 million, translating into $1.64 of diluted earnings per share, exceeding our guidance by $0.05. Turning to the balance sheet and cash flow, third quarter cash flow from operations was $258 million, and capital expenditures were $191 million supporting further revenue growth in the second half of the calendar year as well as the necessary technology investments for emerging 5G opportunities in IoT markets. Dividends paid were $58 million, and we've repurchased 2.5 million shares of our common stock for a total of $240 million, bringing our total share repurchases this fiscal quarter to over 5 million shares. In fiscal '18, we have returned essentially all of our free cash flow back to the shareholders through our share repurchase program and dividend payments. We enter the quarter with a cash and investment balance of over $1.6 billion and no debt. Now moving on to our outlook. For the fourth fiscal quarter, we expect revenue to be up 11% to 13% sequentially or $1 billion at the midpoint. We anticipate further gross margin expansion with fourth quarter gross margin between 51% and 51.5%. We expect operating expenses in the fourth quarter of $135 million. Below the line, we expect roughly $4 million in other income, a tax rate of 9%, and a diluted share count of 182 million shares. Accordingly, at the midpoint of these ranges, we plan to deliver diluted earnings per share of $1.91, up 16% sequentially. Finally, today we also announced a 19% increase in our quarterly dividend to $0.38 per share, reflecting our confidence in Skyworks' business model and sustainable cash generation capabilities. With that, let me turn the call back to Liam.

Thanks, Kris. As our results and outlook demonstrate, Skyworks continues to financially outperform, driven by content-rich design wins covering a number of strategic customers and applications, increasingly strong momentum in broad markets, world-class operational execution scale, our Sky5 platform enabling the 5G applications of tomorrow, decades of experience in developing innovative solutions over successive technology generations, and finally, superior cash flow performance allowing us to out-invest our competition while providing premium returns to our shareholders. That concludes our prepared remarks. Operator, let's open the line for questions.

Yes, thanks for taking the question. And I'll just start with a clarification for you, Kris. Kris, could you help us with the segment breakouts in the fiscal third quarter and then as we look at the guidance for the 11% sequential growth in the fourth quarter? Can you provide some color on how the segments can perform within that?

Yes, Craig. So broad market in Q3 was approximately 30% of total revenue, was actually slightly above 30%. Mobile was approximately 70% of total revenue. Speaking about the broad market, we continue to see really nice growth there. We are growing in the low to mid-teens year-over-year, and so we are now at a $1.1 billion annualized revenue run rate. So we see really good strength across the board, especially the IoT segment that includes the connected home, the connected car, machine-to-machine industrial applications, and some consumable applications. In addition to that, we also see some really good traction there on the infrastructure segment, so broad market is doing really, really well.

And the second part of that clarification question was the fourth quarter. Would you expect broad markets to continue to grow in the fourth quarter? Historically it’s been up in some quarters and down in others?

No. We definitely expect strong sequential growth in broad markets into the fourth quarter. So continue on that low to mid-teens year-over-year growth.

Thanks for taking my questions and congrats on the results. First, the China business, can you talk about how your Chinese OEMs fared in the June quarter? And then update us on the size of that group relative to revenues and talk about how we should be thinking about the momentum of that business in the second half of calendar '18?

Sure. Yes. So Q3 actually China fared pretty well despite some of the choppiness in the market and the specter of trade dynamics. We were able to put up some sequential growth in Q3. If we look at China for Skyworks, it’s about 25% to 30% of revenue. Of course, in China for us is mobile, infrastructure, IoT, and many parts. It’s been a great region for us to deploy into emerging markets. A number of our players in China, Oppo, Vivo, Xiaomi, etc., also deliver globally to some of the most emerging places. So we’re interested in that; we benefit from that. We should also note that we have a very diverse set of baseband partners that help us deliver in China. So we’ve got within Huawei, their HiSilicon product, partnerships with MediaTek, Intel, Qualcomm. So we’ve got all the bases covered and our position there was solid.

And then on margins, last quarter, you talked about progress towards the 52% target in the second half with some cost initiatives to kick in. It looks like based on the guidance it's going to be dropping down to 54%, 55% next quarter, so some progress there. But can you just update us on your latest thoughts about some of those costs initiatives and maybe a timeline for when we can get closer to that target? Thanks.

Right. From a gross margin point of view, I’m pleased with the progress that we continue to make. So in the June quarter, Q3, we were up 20 basis points sequentially as well as 20 basis points year-over-year. For Q4, we just guided 51 to 51.5, which is up 10 to 60 basis points sequentially, so at the midpoint, up 35 basis points. So we continue to make really good progress towards our target model of 53%.

Chris, maybe I’ll start with you. Good progress, good follow-through on the capital allocation via the dividend increase. But I was just a little puzzled and I was hoping you could answer these questions. Free cash flow came down a lot this quarter, thanks largely to AR being up a lot as well as inventory. Could you help us understand what are the dynamics there? And also kind of related to that is CapEx was up a lot and you mentioned capacity as well as new investments. So does that mean that CapEx would be higher than what you had earlier guided to? And then I have a quick follow-up for Liam please?

Yes, first of all, we have a very strong cash generation business model, and that continues to be very strong. Obviously, there are going to be some seasonal situations. Typically, Q3 is somewhat of the softest cash generation quarter in part because inventory is going up both in dollars as well as days of inventory as we are anticipating a strong ramp in the September and December quarters. From a receivables point of view, we saw an increase of the receivables both in absolute dollars as well as DSOs because of the seasonality. Typically in April and May, you still have a seasonal decline, and then starting in June, you see the seasonal increases. As a result of that, Q3 was somewhat backend loaded from a billings point of view. As a result, you see slightly higher DSOs, slightly higher AR. That has somewhat of a muted impact on cash generation within the quarter. But if you look at it from an LPM point of view, we continue to generate very strong cash, cash from operations as well as free cash flow. Having said that, CapEx in the quarter Q3 was $191 million. It was definitely a heavy CapEx quarter. Again, all or most of the CapEx there is related to capacity expansion in preparation of the steep ramp that we have in front of us here in the September and December quarters, as well as some technology-related investment as we continue to be a technology leader and expand our capabilities there as well.

Okay. And clearly no lack of confidence because you have paid up a lot I just wanted to make sure, I understood the dynamics. So, Liam, just on the third calendar quarter, when you look at the mobile and the trends that you're seeing there, and I don't even know if there is anything such as seasonal anymore. But how would you characterize the environment? Is it somewhat seasonal, more or less, worsen that or better than that? Thank you.

Sure. Yeah. So you're saying the third calendar quarter. We started to see this time of year preparation for some sizable ramps with premier customers. And that work is ongoing. We are very comfortable with our ability to move content up and actually expand the reach of our content, and that's even more important. We're bringing more technologies, higher grade functionality to really less connectivity, improved data rate, and reduced latency managing some of the more intricate designs on our DRX platforms and bringing in MIMO architecture. We're in the very early innings of those ramps. Again, calendar Q3 and then moving into calendar Q4 where the numbers should come up again. That's how it's playing out right now. We have very good visibility on this as well.

Yes. Thank you. Can you discuss in terms of how you're thinking about guidance just with the ZTE ban recently lifted? How does that incorporate or not into the September quarter?

Yeah. So our business with ZTE was approximately $25 million to $30 million per quarter. Obviously that was not there in Q3 and the June quarter. In the meantime, the ban has been lifted, which is good news. However, it will take time for ZTE to rebuild their supply chain that could take multiple months, if not multiple quarters. So we do expect a little bit of revenue related to ZTE in Q4, but it’s just a couple of million dollars.

Okay. Thanks for that. And then just as a follow-up on capital allocation and just to step up noticeable uptick in buyback increasing the dividend. Liam, can you talk about that move in the context of how you’re also viewing M&A opportunities?

Sure, absolutely correct. Yes, I mean, fortunately, the cash machine and the Skyworks engine is continuing to do well. The market backdrop is, I believe, very favorable for us. We understand mobile, there are a lot of great developments happening there. We're advancing the technology, expanding the reach, and making some really strategic investments. We also have 5G upon us, which is going to present an incredible opportunity for Skyworks and our ability to do the complex things well. In parallel, we talked about broad markets and double-digits. So there are a lot of really needy opportunities on the table today with the card business. Having said all of that, we’re fortunate to have the cash generation, the balance sheet, and the powder to pursue acquisitions when they make sense. We'll continue to look at that, and we have been looking at it, but we will maintain a very high bar and a great deal of vigilance on transactions if we go forward.

Let me question, Liam, I wanted to ask you; you mentioned that number of OEMs in China is going to create as you look as basic in this business in China the competitiveness if we saw that this balanced solution is that becomes a bigger part of mix for the next couple of years?

Sure, Blayne. I think if you look at China, as I mentioned, we’ve been working that region for years and have great partnerships and relationships and some incredible success stories within the leading players. As I mentioned earlier, we’re able to play all the angles. So as we start to move into extending in the 5G, where China is going to be a big player, there are going to be some new opportunities that will require unique filtering, expanding carrier aggregation, and a much greater focus on downlink data speed, data rates, and latency management as we excel with our DRx technology. The ability to solve these problems can differ based on the supplier and customer’s needs. What we bring to the table is really that high degree of configurability; we can go in and leverage TC saw, our DRx, and our homegrown gallium arsenide in our packaging to create really unique solutions, so each customer gets exactly what they want. As you know, in China, you have more of a proliferation of models rather than one or two flagships that dominate the global market. So the ability to work with each customer and get it right based on their needs is crucial. And I think it gives us a chance to really exceed our numbers as we get into 2019 and beyond.

Just a final question. I'm interested in how the timing of the marketing ramp this year compares to the last couple of years, especially considering that last year was quite different. As you review that guidance, how does it line up with our market overall?

Yes, so you're referring to the large customer ramp, is that right, Blayne? Yes, I think I assume that to be the case. What we're seeing right now for ramps is going through the second half of the calendar year in a predictable cycle. Obviously, there will be some production that we need to put forth now which we are doing to support our larger customers for those ramps. What we see today just on the outlook and the projection is that things are tracking similar to more historical cycles, and we’ll be prepared to deliver on that.

Yeah, hey guys. First of all congratulations on solid results by you guys. At your largest customer, Liam, I was curious if this new generation of phones has a content increase that's built in. And I'm curious if you could talk about maybe generally speaking if you saw content increase and if you did, what kind of category would you put that, double digits, single digits just broad color? And then I have a follow up.

Yes, I think without going into too much detail, Harsh, but obviously it's our mission every cycle to bring a greater level of technology and performance to our customers. I'm confident that that's happening again here now with the burden on mobile technology and the requirements continuing to stretch and become more daunting. It's great for Skyworks. We talked about that. We have a wide array of technologies from Bluetooth to Wi-Fi to LTE, GPS, DRX all throughout mobile. The ability to create diversification across platforms is a big reason we're able to raise content every year. Some of the new technology nodes, including 5G, are not factored into the numbers today, but we're working on it now, where we have the blueprints and the prototypes in our labs and we're prepared for the '19, '20 and beyond ramps in 5G.

Understood. And then for my follow up, I think you said in the last call that you expected 3Q fiscal, sorry, 3Q calendar, which was the September quarter to be up and then you expect the 4Q calendar, which is the December quarter, to be up again. Is that still the case? I mean, do you expect that to play out again? Is that the way it looks this year?

Yes, absolutely. That's right.

Thanks for taking my question. Maybe first one for Kris on CapEx. I don't recall Kris whether you gave the number for Q4. And then as part of that, is 10% still a good assumption to use for CapEx for the next 1 or 2 years?

Yes, absolutely. So if you look even on a last twelve months basis, we are approximately 10% CapEx to revenue. There is some seasonality; some quarters are higher, a lot of quarters are lower. But if you look at it on a full year basis, this year and even the next couple of years, on or above 10% CapEx to revenue is a good number.

Got it. And then Liam, as we look at the back half, as I look at your September quarter outlook and maybe assuming December is kind of seasonal, do you expect mobile sales to be up year-on-year? Because if content is up, is it just that we’re still working through some of the unit fluctuations? At what point should we start to see your mobile sales start to grow year-on-year?

Yes. Year-over-year growth is definitely in the cards for us. We’re not guiding December on this call, right? So we just have to look at another quarter with you. But we are gaining content; we are seeing our reach of technology expand as I mentioned. We do expect solid sequential growth into December. We haven’t finalized exactly what that number is. But we absolutely expect that to be in place. It will be up year-over-year as well if we follow through with the solid sequential trends. That’s all we can do for now, but we feel good about making that happen.

First question I have is a little broader. We’ve seen major North American customers starting to reevaluate their bond and trying to minimize it as much as possible. And just given the history that we’ve seen with other Chinese OEMs almost kind of mimicking what this North American customer does. Do you expect to see this trend flow through at Chinese OEMs or do you think that content is still increasing there?

Yes, so what we are seeing in the Chinese OEMs is today at face value, the content vis-a-vis some of the larger players is that the China opportunities are just lower in dollar value, but they’ve been increasing. You may have an LTE product that has $4 to $5 of content that potentially can move to $6 to $7, and we pursue that. If you look at the larger players that lead the market, the content opportunity is much higher. So if anything, if we could get some of the mid-tier China brands to mimic more of 1 and 2 players in the industry, that would be good for us. There are differences regionally, but we honestly see the need in every case for performance and products are selected based on how well the product performs in their application, not so much on how much does it cost.

And then for my follow-up, speaking on the topic of China, I know the tariffs recently have kind of affected everyone a little bit differently. How do you expect that to affect your business operations, if at all? Or do you fear any retaliation from China will affect your business outlook?

No, we have seen very little or no impact from the trade war on our business, except for the export bandwidth issue with ZTE where we lost revenue in Q3 and Q4. The ban has been lifted, but it will take some time to recuperate that revenue. If you look at the trade war on the tariff side, we are an exporter of components from the U.S., Singapore, and Mexico into China and many other countries. There are no new import duties or tariffs on those components, and so that doesn’t impact us at all. We will continue to evaluate and monitor any new developments, but for now, we don’t see any impact on our business.

Thank you very much. Kris, it seems that in December your 2018 guidance indicates you might grow around $15 million sequentially in the third calendar quarter. If that includes just a few million dollars from ZTE, then it suggests that the broad markets business is expanding by more than 20% year-over-year. Are there any one-time factors in September, or is that truly the correct year-over-year growth rate moving forward? Thank you.

We can probably take this offline on the math. What I see here is that broad market in Q3 and in Q4 fiscal calendars is growing at that low to mid-teens year-over-year.

Okay. And then can you talk a little bit about the competitive environment? Are you seeing Qualcomm being sort of anymore of a player? They now seem to have all the pieces with the TDK JV and Winsemi and stuff. Do you see them as a major account in your current state? Thank you.

Yes, the Qualcomm situation - look we respect Qualcomm, they're a great technology player that has been in mobile for a great deal of time. But if we look at the landscape today on programs that we've been pursuing and those that we're already in, we haven't seen a significant effect. Let me also remind you that there are a number of platforms where our assets and other chipsets will line up right next to the Qualcomm baseband. We do have an ability to be a part of their system with our product. Their fully integrated solutions, we haven't seen too much of that impacting our revenue growth.

I know you can only comment as much about ramping in North America for the second half. Are you seeing in general a departure from the typical band frequency range that used to be in previous years? And what are the new design wins that you have for the second half? Would you say there is an incremental market share that you see driving this guidance, which is the strongest sequential revenue growth for the past four years for the quarter?

Sure. Yes, we continue to see very rich content opportunities put forth with the leading players in the industry. That trend continues for successful generations. Bands can be added as customers want to gain more reach with their customer base so that happens. The important thing is the more bands you get with technology, the more bands that you bring into tuning applications bringing in downlink opportunities on DRX and uplink opportunities on Sky1. Now thinking about getting into 2019 and 2020 where we have unique 5G opportunities that are not yet resolved is going to put tremendous pressure on systems performance and a great opportunity for those that can deliver. We're well prepared for that. We certainly have good visibility on the designs that will be required to make these numbers happen. It's about execution right now, and that's what we've been doing for years. We're looking forward to executing on the ramp and following up over the next several years as we bring 5G to the market.

And then as a quick follow-up outside of North America, do you see any pockets of inventories in the smartphone supply chain? Or would you say that we’re at normal level relative to this time of the year?

Yes, we are absolutely at normal levels for this time of the year.

Thank you for taking my question and congratulations on consistent execution and the dividend hike. First question for Liam on 5G. You guys have a very strong portfolio with Sky5. Can you just talk about when should we expect significant revenue ramp in your 5G products? I think in the past, you guys have talked about double-digit growth in fiscal second half '19. So is there any update on when we should expect the significant ramp in 5G sales?

Sure, great question. I mean, the work is underway right now and I’m really proud of our team’s ability to get in front of this and become one of the first movers in 5G. We’re thrilled to be in that position. What we’re seeing is a lot of design activity on both the infrastructure side and on the connectivity within smartphones. We think you can get different answers, but we see revenue being posted probably by 2020, maybe late '19. But 2020 is where we expect to see real revenue. To get there, there’s a lot of development work required, and our teams are working closely with our customers and baseband providers and the infrastructure side to ensure that all of this great technology comes together efficiently. Additionally, Kris mentioned we’re making strategic capital investments that are unique to executing in a 5G world — very complex products that we want to excel at delivering. We have already conducted some trials and tests with our 5G Solutions, and things look promising. We’re going to continue to refine and position ourselves to deliver at scale when these products hit the market.

Great. And then a follow-up, can you provide an update on your in-house manufacturing program? Are you moving towards some manufacturing capabilities?

Sure, I don’t want to share too many details about that technology right now. You know what's pretty well. We have some very crafty designs that will allow us to address all the necessary frequency bands in both LTE and 5G. The work at this point is progressing very well, and we’ll share more on that soon.

I want to ask a question on mobile differently than others. So, if you look at the mobile business in the September quarter, it looks like it’s basically flat or slightly down from a year-over-year perspective. If you can break out the content gains versus maybe the unit demand weakness among the large North American and Korean players in China, where are you seeing say the content gains versus maybe the unit demand weakness and so forth that brings it to relatively flat or slightly down? Thank you.

Yes, we’re trying to unravel that the best we can. I mean, certainly, we’re not seeing China doing as well as we’d hoped. There are still some real numbers involved. We thought that would be a little bit better. Some of that lackluster is reflective of ZTE, which is real. We talked about that $25 million to $30 million a quarter that’s off. Samsung hasn't been as strong as other large accounts; they are somewhat stable but we haven't seen the uptick there that we thought we would enjoy. Some of that is a choice we've made in certain cases to not chase commodity business which serves us well. The larger mobile customers continue to advance the technology. All of that converges together for us; there is a bit of a unit issue that jumps around. You all know, with any customer's product ramp, it doesn't move 100% to one device. There is a roll-in phase, an in-phase-out. So it’s a combination of new product and past year models involved. The content acquisition is what we drive, and I'm happy with the team's ability to make that happen. Yes, a lot of that is in this high-performance tenant arrays and base stations. These new functionalities are required to make 5G work. You see a slow roll on infrastructure right now as a catalyst to move to 5G. Also, we’re seeing a step-up in small cell infrastructure, small cell base stations occurring. If you look out long into 5G, we could even delve into millimeter-wave technology, which we haven't house, that can drive neighborhood-level deployments that will incorporate small cell-like functionality. That opportunity is out there, but all of this sits squarely in our strike zone.

Thank you all. I appreciate your time this afternoon. I look forward to seeing you at conferences going forward.