Broadcom Inc. (AVGO) Earnings Call Transcript & Summary

Welcome to Broadcom Inc.'s Second Quarter Fiscal Year 2021 Financial Results Conference Call. At this time, for opening remarks and introductions, I would like to turn the call over to Ji Yoo, Director of Investor Relations of Broadcom Inc. Please go ahead.

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, Infrastructure Software Group; and Charlie Kawwas, Chief Operating Officer. Broadcom also distributed a press release and financial tables after the market closes, describing our financial performance for the second quarter of fiscal year 2021. 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 1 week. It will also be archived in the Investors section of our website at broadcom.com. During the prepared comments, Hock and Kirsten will be providing details of our second quarter fiscal year 2021 results, guidance for our third 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 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. I'll now turn the call over to Hock.

Thank you, Ji, and thank you, everyone, for joining us today. In Q2, semiconductor solutions revenue grew a strong 20% year-on-year to $4.8 billion, with infrastructure software revenue growing an expected 4% year-on-year to $1.8 billion. Consolidated net revenue was of $6.6 billion, up 15% year-on-year. Now on the last earnings call we had, we talked about how strong broadband and networking bookings were from hyper cloud and service providers, even as wireless was declining seasonally. In Q2 just passed, not only do we see broadband and networking sustaining, we now see a recovery of bookings from enterprise. And on the supply side, hourly times have now stabilized, but the volume of bookings we are experiencing today continues to grow. Now we intend to meet such demand, and in doing so, we maintain our disciplined process of carefully reviewing our backlog, identifying real end user demand and delivering products accordingly. With that as context, let me provide you more color. Starting with broadband, which interestingly now is going through somewhat of a renaissance. Revenue grew 28% year-on-year and represented 18% of our semiconductor revenue. As discussed during our Broadband Teach-In, the work, learn and play from home environment is driving global service providers to expand connectivity to the home. In our broadband carrier access business, PON fiber or otherwise known as PON grew over 40% year-on-year, mostly with existing generation 2.5G. But with next-generation 10G PON representing only 30% today, there is significant room for content growth as 10G PON deploys over the next few years. Not to be outdone by fiber, cable operators in the U.S. are driving deployment of DOCSIS 3.1 cable modems, we saw an 80% year-on-year growth, and planning to accelerate the upgrade to next-generation DOCSIS 4.0. Our broadband technologies, in fact, are enabling service providers to complement the 5G they deliver -- to deliver best experience for consumers. Now overlaying all this last-mile broadband upgrades, we see a demand surge for the latest WiFi 6 and 6E technology to enable the last 100 feet of connectivity in homes. Broadcom has emerged as the clear market and technology leader in WiFi for access gateways to the home and to enterprises, with over 50 million ports shipped in Q2 alone or a year-on-year revenue growth of some 30%. On the other hand, as we might expect, with the push into higher-performance fiber, copper DSL, digital subscriber line deployments for wireline broadband, declined 30% year-on-year. And with a lack of live events during the pandemic, video declined 20%. But with the onset of 5G, service providers are competing for subscribers, leading to technology upgrades globally in fiber, cable and WiFi connectivity. We're seeing this investment cycle in broadband extending into 2022. And so for Q3, we expect to sustain double-digit year-on-year revenue growth in this segment. Moving on to networking. Networking grew 10% year-on-year and represented 32% of our semiconductor revenue. We experienced tailwinds from hyper cloud and telcos, partially offset by headwinds from enterprise. Revenue for switching was up 30% year-on-year, primarily driven by the strong ramp of our Trident and Tomahawk 3 for over 400G platforms and hyper cloud data centers. In the network, service providers have been investing in 5G infrastructure worldwide, where the demand for Jericho2 at the metro core and Qumran at the edge have been robust with revenue up 35% year-on-year. On the other hand, enterprise demand in networking has not yet recovered, still down double digits from a year ago. But as we go into the back half of the year, we expect to see hyper cloud upgrading to our next-generation Trident, Tomahawk 4 or over 800G switching platforms and sustained strength by service providers in network routing. And accordingly, in Q3, we expect networking revenue to maintain the trend of low double-digit growth year-on-year. We found the complete recovery of enterprise demand. Speaking of enterprise, let's talk about server storage connectivity, which represented approximately 12% of semiconductor revenue. This end market is largely driven by enterprise. And in line with our guidance, revenue was down 16% year-on-year. You may recall, however, in Q1, this was down 22%. And as the economy starts to recover, we are seeing an improving demand trajectory. And so in Q3, we expect server storage connectivity revenue to be down high single-digit percentage year-on-year. With the launch of Intel's Ice Lake, AMD's Milan as well as future ARM-based servers, this space is turning quite exciting and innovative for us, both in hardware and software. And we will provide, obviously, more color during our next teach-in in July on our server storage business. Moving on to wireless. Q2 revenue was down 16% sequentially, reflecting seasonality, with wireless representing 34% of semiconductor revenue mix. Nonetheless, on a year-over-year basis, wireless revenue was up 48%, reflecting a very favorable compare year-on-year as well as content increases in FBAR and WiFi. In Q2, we were able to ship more than we had originally planned. And accordingly, in Q3, we expect the growth trend in wireless revenue to sustain but at over 30% year-on-year. Finally, industrial and other represented approximately 4% of Q2 semiconductor solutions revenue. Resales grew 34% year-over-year in Q2, driven by recovery in automotive and China. Inventory in the channel continues to deplete as what we shipped in the distributors grew only 23%. Turning to Q3, we expect resales to continue to grow double-digit percentage on a year-on-year basis. Summary, Q2 semiconductor solutions segment was up 20% year-on-year. And in Q3, we expect revenue growth year-over-year to be of a similar amount. Turning to software. In Q2, infrastructure software produced another quarter of steady and predictable results as revenue grew 4% year-on-year and represented 27% of total revenue. Now if we exclude professional services, our enterprise software revenue grew 7% actually year-over-year. And a further indicator of the quality and sustainability of our products, over 90% of our software bookings represented recurring subscription and maintenance with an average contract life span from core customers pretty much close to 3 years. We continue to believe our infrastructure software business is on track to grow at or better than mid-single-digit percentage year-over-year, which is again what we expect to see in Q3. Summarizing this, demand continues to be robust, and so our Q2 consolidated net revenue grew 15% year-over-year. We expect the momentum to sustain in Q3 and total revenue to be at $6.75 billion or up 16% year-on-year. With that, let me now turn the call over to Kirsten.

Thank you, Hock. Let me now provide additional detail on our financial performance. Revenue was $6.6 billion for the quarter, up 15% from a year ago. Gross margins were a record 75% of revenue in the quarter and up approximately 180 basis points year-on-year. Operating expenses were $1.2 billion, down 1% year-on-year, driven by lower SG&A, offset in part by increased investment in R&D. Operating income for the quarter was $3.8 billion and was up 25% from a year ago. Operating margin was 58% of revenue, up approximately 470 basis points year-on-year. Adjusted EBITDA was $4 billion or 60% of revenue. This figure excludes $133 million of depreciation. Now a review of the P&L for our 2 segments. Revenue for our semiconductor solutions segment was $4.8 billion and represented 73% of total revenue in the quarter. This was up 20% year-on-year. Gross margins for our semiconductor solutions segment were approximately 69%, up 290 basis points year-on-year, driven primarily by higher product margins. This margin improvement comes from content growth as we deploy more next-generation products in broadband and networking end markets. Operating expenses were $795 million in Q2, up approximately 2% year-on-year as we invested in R&D and streamlined SG&A. R&D was $702 million in Q2, up approximately 6% year-on-year. Q2 operating margins increased to 53%, up 580 basis points year-on-year. So while semiconductor revenue was up 20%, operating profit grew 35%. Moving to the P&L for our infrastructure software segment. Revenue for infrastructure software was $1.8 billion and represented 27% of revenue. This was up 4% year-on-year. Gross margins for infrastructure software were 90% in the quarter, up 100 basis points year-over-year. Operating expenses were $355 million in the quarter, down 8% year-on-year as we've completed the integration of Symantec. R&D spending at $228 million is up 1% year-over-year. Operating profit was up 10% year-on-year on top line growth of 4%. Operating margin was 70% in Q2, up 360 basis points year-over-year. Moving to cash flow. Free cash flow in the second quarter was $3.4 billion, representing 52% of revenue. Days sales outstanding were 33 days in the second quarter compared to 51 days a year ago. We ended the second quarter with inventory of $1 billion, an increase of $52 million or 5% from the end of the prior quarter. We should also note in Q2, we spent $126 million on capital expenditures. On the financing front, we extended our weighted average debt maturity to approximately 10 years from 9 by exchanging notes. Our weighted average coupon decreased about 5 basis points to 3.7%. During the quarter, we made $1.5 billion in payments on debt obligations, ending the quarter with $9.5 billion of cash and $40.4 billion of total debt, of which $278 million is short term. Turning to capital allocation. In the quarter, we paid stockholders $1.6 billion of cash dividends. We also paid $461 million in withholding taxes due on vesting of employee equity, resulting in the elimination of approximately 1 million AVGO shares. We ended the quarter with 410 million outstanding common shares and 450 million diluted shares. Note that we expect the diluted share count to be 449 million in Q3. The Board of Directors has approved a quarterly cash dividend on our common stock of $3.60 per share in Q3. Based on current trends and conditions, our guidance for the third quarter of fiscal 2021 is for consolidated revenues to be $6.75 billion and adjusted EBITDA of approximately 60% of projected revenue. That concludes my prepared remarks. Operator, please open up the call for questions.

[Operator Instructions] Our first question comes from the line of John Pitzer of Credit Suisse.

Hock, I've got 2 quick ones. First, within your wireless business, you've been able to sign long-term contracts with your key customer, and I'd argue that's benefited both you and them. It's given you the confidence to invest in the business properly and then the confidence that you'll have supply for them when they need it. I'm just kind of curious, given how tight things are elsewhere in the semi business, have you been able to parlay this into any longer-term customer contracts? And what implications might that have as we all start to worry about the "end of cycle"? And then secondly, just on your comments about enterprise recovery, can you elaborate on that? Was that specifically a storage comment? Or is that also a networking comment?

Okay. Let me take the question one at a time. On arrangements with long-term agreements, John, this is something we have been thoughtfully, carefully putting in place with our core strategic customers. We just don't go do it as if it's commoditized. We're very thoughtful about doing it, and we do it in very specific areas where we know for sure that the technology is fairly, fairly difficult, complex to manage and which requires a substantial amount of R&D spending. And we've been doing it for a while now with strategic customers in core businesses. So we just don't do it across the board. And what you pointed out is very, very correct. It's a mutual -- then it's a structure, it's an agreement with mutual benefit. We have the confidence to invest in R&D to make CapEx capacity investment. And in return, we offer the best leading-edge technology in specific areas in a timely manner to our critical customers. So yes, we have been doing it, and we will continue to thoughtfully do it in a very appropriate manner. On the second part, okay, which is -- if you could repeat the question, John? Let me be sure...

Yes, just elaborate a little bit on your comments about an enterprise recovering brewing. Was that mostly within storage? Or was it networking? So I'm a little bit surprised, given some of Cisco's comments, that you're not a little bit more positive on the enterprise network space.

It is across -- it is for enterprise spending. It is -- I won't say across the board necessarily and trying to define enterprise very appropriately. As you noticed in my comments, we've classified service providers, telcos as a separate animal, different from traditional enterprise. And so -- and as I pointed out, based on broadband, telcos have been investing big time. Service providers, telcos have been investing in a huge manner over the past 12 months. But traditional enterprise, the companies, whether it's the banks, the manufacturing sector, various retail customers, airlines, examples, no, these guys are in a recovery mode. And not surprising, we are seeing pandemic easing like, say, in North America. And as it eases, we see a step-up in spending. But we do not see spending spiking up. Now obviously, if you look at some businesses that -- like warehouses that require WiFi networks, campus networking environment, you do see that improving. But to say across the board, all enterprises are just spending money, not -- we are still seeing -- and as I showed that in server storage connectivity, we still see year-on-year, things are not up to what it was a year ago. And that applies not just on data centers, namely compute. It also applies to data centers in enterprise, campus environment. We see less of that but across the board.

Our next question comes from the line of Harlan Sur of JPMorgan.

Great job on the quarterly execution, strong margins and free cash flow generation. Hock, I think as you mentioned, we're still in the early phases of the 400-gig networking upgrade cycle with your hyperscale and telco customers. I know 2 of your big cloud typing customers have already started the upgrade. It looks like there's another 2 more that are going to start the upgrade cycle here in the second half of this year and quite a bit more next year. And then as you mentioned, you still have Tomahawk 4 ahead of you. So given the extended visibility that the team has with the strong backlog, do you see the cloud and telco upgrade cycle and inevitable recovery in enterprise driving continued year-over-year growth in networking into next year?

I don't -- we don't really try to guide more than 1 quarter at a time, first of all, because we're not that smart to be able to do that. But on a broader trajectory, it does appear fairly much the trend, as we said, which is the hyper cloud guidance will push out in the second half, as I indicated, on the data center side on Tomahawk 4, the 800G platform. In fact, we have substantial backlog for delivering in the back half of the year for Tomahawk 4. So we see that going on, and we -- you're right, we see the recovery step-by-step of the enterprise, though I do not see that really taking off in terms of reaching the level it was a year ago, probably until 2022. But what we do not know for sure is would that give pause to hyper cloud in their spending. And that part, I'm just putting everything on the table. We're not sure whether hyper cloud spending will necessarily continue into 2022. We sensed it would. We see some of the backlog. But as enterprise steps up, one really never knows if the economy starts to rebalance in that side. But what we do see in broadband is service providers, the telcos in particular are, for sure, upgrading. And here, this is the longer cycle of upgrade and we see them upgrade. And we see the backlog associated with it through 2022.

Our next question comes from Ross Seymore of Deutsche Bank.

Congrats on the strong results. Hock, I want to dive a little bit into the lead time commentary that you had with that stabilizing. Two quarters ago, you talked about the size of the book, the backlog you had. Last quarter, you talked about the year-over-year and even, in some instances, the sequential growth being so large in bookings. And now we're hearing that the lead times are stabilizing. People could interpret that a bunch of different ways as far as the implication on the demand side of the equation or that supply is catching up to it, or frankly, people are just ordering so far out that they're not willing to extend that any further. So I was hoping to double-click on that lead time commentary and get your feelings as to why it's stabilizing. And do you take that as a positive or a negative?

I'll just make a comment to say we have stretched out our lead times so far, Ross. Good point you bring up -- and I'm glad you're bring it up to give me a chance to clarify a set of quick comments I made in my opening remarks that we are comfortable at the lead times we are on. And so what it is, is customers -- our customers are comfortable seeing our lead time now. But one we have found rather remarkable over the last quarter is that even if our lead times remain stable, consistent, the volume of bookings we receive every week continues to grow. I made that comment and thanks for the opportunity to make that -- reiterate that point. Same lead time, stable for last 3 months, but the booking rate we are seeing every week continues to step up.

Our next question comes from Vivek Arya of Bank of America Securities.

Hock, I had another one on the supply situation. If there were no supply constraints, how fast would your semiconductor business be growing? And kind of part B of that is, what is driving the shortages for you right now? And what are you doing to resolve it? And do you have any kind of gut feel on when the supply situation will become normal?

One of the first -- I'll answer the first and the last. In between, I'm not sure. But on the first, it's -- we will not put ourselves in a situation nor should anyone do it because there's also a certain amount. You do not -- we do not want our customers, and I don't think any of our peers want to do that either, to buy, to hoard, to create buffers, to buy ahead of what they need. So we try to mesh, identify, as I said, and go through a process of rigorously understanding true end demand. In other words, we look for drop date quantities as the term is used in the industry. And we ship to those drop date quantities and maybe a little more. And what you see today is the true growth rate we are representing. We are not hiding what could have been. There's no what could have been. We're shipping to what we believe the customers consider as the true real demand. Now having said that, we may be delivering -- doing JIT, just-in-time. But nonetheless, we do try to fulfill what customer truly want just in a timely basis. And that still continues today, regardless of the size of the backlog we have, but this is really in that regard. And from our perspective, the challenges we have in the supply chain is a constant side challenge. It's to ensure that we get components, whether it's wafers, substrates, getting our products assembled, tested and any other small components on a timely basis to make sure that we can keep this thing running. And if you look at the size of our inventory versus the size of our cost of goods sold or revenue quarterly, you can see that we run pretty close to just-in-time through our entire supply chain. And we've been able to do it and sustain that. And so what we're reporting to you like 20% year-on-year growth on semiconductor components is, in our view, a pretty decent reflection what is truly end demand needs out there. All right.

The next question comes from Timothy Arcuri of UBS.

Hock, I guess I wanted to ask you what you think the long-term growth rate is of your semiconductor business. You're sort of trending to the high teens this year, but that's kind of due to easy comps and you have the compressed iPhone launch and the pull forward of some of these technologies due to the pandemic. So once this all sort of normalizes, what do you think is the right long-term growth rate for the business? Are you still thinking 5%? Or do you think maybe just given the strength of the bookings recently that it could be better than that?