Broadcom Inc. (AVGO) Earnings Call Transcript & Summary

Great. Welcome back. I'm Joe Moore from Morgan Stanley Semiconductors. Very happy to have with us today the CFO of Broadcom, Kirsten Spears. I'll just quickly read a safe harbor. For important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please feel free to reach out to your Morgan Stanley sales representative. So with that, thank you, Kirsten, for joining. I wonder if you could just talk generally about the business environment. And I guess for me, you're sort of describing an environment where you guys are being very vigilant at keeping your customers from building excess, but you're also talking about being kind of booked out with NTRs through the year. Is there a point where that sort of flips and where your people are being told to take order commitments that they've had? Like just how do you balance out those dynamics?

I'd be happy to talk about that. First of all, I'm really happy to be here today. I've been with the company since 2014, so I came along with the LSI acquisition and you know how acquisitive Broadcom has been. And before we get started, I just want to kind of quickly go over 2022, a $33 billion company. We have the highest margins in the industry. Our operating margins are 61% last year. And so with 20,000 employees, that translates into $1 million per employee contributing to operating profit, which I think is phenomenal. Our free cash flows came in at about 50% of revenues last year. We were able to increase our dividend by 12% year-over-year to $18.40 a share or $4.60 a quarter. So Broadcom is a tremendously well financial managed company. And I think that our watchfulness translates well for investors. And so just to get started, I'm so happy to be here today. And I'm happy to talk about -- that's essentially a backlog question, but we worked really hard to make sure that we ship to real end demand. I know this, we say it all the time. You hear us saying we scrub our backlog fastidiously and we work closely with our customers. It's a strategic relationship. We don't want to overship into the ecosystem. It's not going to do you any good, it's not going to do me any good. And so if our customers came to us saying, hey, can you work with me on this order, we would work with them. Now you're correct. Our orders are not cancelable. But we'll work with our customers to push things out. So in the event of a recession, which I will step back for a second and just let you know that I'm one of those, that I'm in the camp of a soft landing despite what you've all heard today, I still believe that we're going to -- it's going to be okay. We've been through a lot, and we've made it so far. So I mean I -- to end on that, a very well financially managed company, and we would work with our customers.

Great, thank you for that. Maybe we could talk to some of the financials tactically. Your R&D was down in Q1. You sort of described an environment where you're still hiring, you're adding people. So can you kind of talk about what we should expect from OpEx for the rest of the year?

Oh, I'd be happy to talk about that. Look, we're spending on R&D. It didn't happen in Q1. We pushed some projects out, but that doesn't mean it's not going to happen. We are hiring, definitely. So you'll see that project spending come back in Q2. I'd like to step back and just provide you my perspective on the company in terms of research and development. We're innovators. We are a technology company. We have 17 hardware divisions. And in each one of those divisions, we're either the market leader, the incumbent and they're sustainable into the long term. So we have to spend money on research and development so that we keep a cutting edge. We've got to stay on top of the technology to maintain our incumbency. So we're spending, definitely spending money. Out of the 20,000 employees that I mentioned we have, 80% are engineers. So definitely technology, innovative company. I would expect R&D spending to be higher in '23 than it was in '22. So definitely spending, definitely hiring.

Great. And then can you talk to the gross margin trajectory, both what you saw in the most recent quarter and what you see happening over the rest of the year?

I'd be happy to talk to that. Our gross margins came in about 10 basis points higher than we expected, and a lot of that was on end product mix. Keep in mind, we have some of the highest margins in the industry, right? So we're -- we feel really good about our gross margins. I then guided gross margins up 150 basis points from Q1 into Q2 basically on product mix. In our wireless end market segment, we have some of the lowest margins in our portfolio, but they're still pretty good. And so those revenues will be down in Q2. And then on the networking side, our revenues are going to be coming up. And as we've said many times, those are our richest gross margins in our portfolio. And so that's essentially why the 150 basis point increase. And we started guiding gross margins just recently, just to give you more color essentially on it. I feel like it was necessary to do that.

I appreciate that, thank you. Talk through some of the semiconductor end markets, maybe starting with networking where your results have been really good. Obviously, you have a lot of product cycle momentum there. It's an area where the customers are still seeing strength, although some of the suppliers have started to talk about inventory. So maybe if you could just talk generally to what you guys are seeing in enterprise networking.

Certainly. Our networking business, we just reported last Thursday, and so we reported Q1 revenues up 20% year-over-year. And then we guided for Q2, up 20% year-over-year as well. And so as all of you know, in our networking business, we have a 50/50 split between enterprise customers and the other half is hyperscaler, telco and service providers. And I see strength across all of those customers. We did highlight some fun new things on the call relative to networking. You all heard about generative AI. That's the latest buzz that's out there, and we certainly talked about it as well. We also announced our Tomahawk 5, 51.2 terabit switch, which has the best 100 gig SerDes out there in the market today, by the way. And that will come out in 2024. In addition, we announced a product called Bailley, which is our co-packaged silicon optics solution that we've been talking about for a while, and that will come out about 6 months after Tomahawk 5 does. Note that with that particular design, we commingle all of the active components into the silicon, which effectively gives you more reliability and lower power which is very exciting. And we also announced just yesterday our new 800-gig PAM-4 DSP PHY with integrated TIA and drivers. It's a big deal because you're integrating 3 technologies into 1 chip, and that integration drives 25% lower power. And that's, by the way in 5-nanometer CMOS. So that's actually a really big deal as well.

Great. Talking about some of the fun things, the generative AI, in particular, you guys talked about strength in that market from the Ethernet side, you talk about strength in customer silicon. But that market is really just kind of getting started from the sense of NVIDIA had actually weakness in the backward-looking numbers and is talking about strength going forward. So what's your visibility into what that opportunity might look like and then maybe we can dig into the custom silicon piece a little bit.

Yes, when it comes to generative AI, it seems like there's a hyperscale war going on out there that -- and I would say that in the last 90 days, this has just come to our attention first and foremost. And so just remember that with generative, it's in early innings for us. We can't really have much visibility beyond 2023. But it is in the Ethernet switch space, which is exactly where that's at. I think at the heart of it, the way I look at it, and to explain it in layman's simple terms as I possibly can, is that as generative AI exponentially starts to grow, what happens is the networks where Broadcom plays become equally important, as important as the AI engines of the GPUs. So that's kind of the gist of what's going on. That network where we play becomes super important. We also talked about compute offload and we said that we'd grow $1 billion. And compute offload, this is something that we always like to talk about. I would tell you that this is just with 1 customer, and we view it -- it's an ASIC engagement with 1 customer, DPUs and other products. But because it's 1 customer, we tend to look at it as more opportunistic.

Great. And understanding you don't want to talk about the individual customers, but how much emphasis do you put on those opportunities? Obviously, the hyperscalers are putting a lot of energy into having their own custom silicon. Do you look to broaden out those relationships beyond DPU over time?

Certainly, we would always look to broaden the relationships with our hyperscalers.

Great. Okay. Maybe you could talk to the server storage and connectivity business, the growth in the quarter very strong. Can you just talk about generally the prospects in that business and what you're seeing from customers in that business?

Most certainly. I think we still believe the server storage business is quite strong. I mean we just reported last week and server storage was up 57% year-on-year, and we guided for growth to moderate to 20% year-over-year in the second quarter. And the reason for the high growth, and by the way, the 57% growth year-on-year, that's been going on for about 5 quarters now. So what happened there is we saw people migrating to our next-generation MegaRAID products in addition to content increases. And so you'll hear us talk about, we were selling chips before and now we're selling chips on boards and selling that as a complete solution. That's what I mean by content increase. So the combination of those 2 events, early adoption of next-gen MegaRAID and the content increases, led to the substantial year-over-year growth that we've seen for the last few quarters. But we feel really good about the server storage business. When we talk to customers, they're still spending in our space, and so it's really good. We feel good about the business.

Are you seeing some of the headwinds that others are talking about? I mean, it seems like that's really high growth that you're talking about. We've seen growth, obviously, in enterprise drives, slow down a little bit. We've seen some of the weakness. Is that -- are those product cycle drivers you're talking about just trumping those areas that are a little softer?

I would have to say yes. We're not seeing the decline at this point.

Great. And then the Broadband segment has really outperformed probably doesn't get quite the attention. Can you talk about the upgrade cycles that are driving that growth?

Certainly. The broadband business does get overlooked, but I'll talk about it a little bit today, so that we bring it front and center. It grew 34% year-over-year in Q1, and we guided Q2 to moderate to 10% year-over-year. And when you think about our broadband business, it's important to remember that it's a multi-deployment, multiyear process, right? So the customers that we're selling to are telecommunications companies and service providers like cable operators, right. So it's all about bringing broadband to the home. So telecommunications companies can increase their ARPU, right? And but the deployment would take time. And so the areas where you see strength is going to be in like DOCSIS 3.1 and PON. So DOCSIS 3.1, the coaxial cable, and PON or fiber, as you hear it described as being, those are actually growing, and they take time to lay the groundwork and get that all put in place. And as you know, it's all about getting broadband to the home. And that is supported by governments all over the world, North America, Europe and then other countries beyond that. So we feel really good about it. It's a pretty strong business.

Okay, great, and then rounding out your semiconductor business, we can talk about the wireless business strategy. What's your focus there? Obviously very focused around a single customer. What's your visibility into that customer and content over the course of the next couple of years?

I think we feel good about our wireless business. Always have, to be honest. I think there is just 1 customer in that space, as you all know, so I'll be careful what I say. But what you've got to remember with that particular customer is that it's an ASIC engagement. It's basically -- an ASIC engagement is a multiyear arrangement with a customer. You've got to be in there with them on their design plans and what they're doing very, very early on. And so we sell our technology to this particular customer across all of their products, right? For instance, we sell WiFi, Bluetooth technology, inductive charging, GPS, sense touching, those high-end RF filters. So it's pretty pervasive and a pretty strong business, very, very strategic customer for us.

Right. So all the segments are really robust. And I guess then going back to the backlog question that you alluded to in the start, that's different than what a lot of other people are seeing in these markets. How much of that do you think is just a function of the product cycle strength that you have? Is it the way you run the business that you've sort of kept that inventory excess from building up where other people have seen that? It sounds like you're almost in a different world than a lot of other companies selling into these same markets right now.

It's a combination, right? We're the incumbent in the end markets that we participate in. We're the market leaders. We have really good technology. We're a technology company, and we innovate. We work hard to maintain the edge that we have. In addition, Broadcom is a very well financially run company. We're careful. I mean we run Broadcom like it's a start-up, right? We watch over everything that's going on. And I think it translates into the numbers that you see. I've said it before, but that's really what it is. We don't overstock inventory into our customers in the ecosystem. If you look at our inventory on hand, I only have 78 days on hand. So really, it becomes virtual inventory in the form of backlog. It's kind of the same fundamental principle we've said all along. If you've got good products and you've picked good assets through acquisitions and you've focused and kept your eye on the ball and you run it well, I think you get the numbers that we have.

I know it's been a great financial execution. Can you talk to the shortage environment that we've been in, in semiconductors over the last 12 months? It doesn't seem like from the way you've described it, that Broadcom has been a major factor in those shortages, but those shortages have existed. Again, to what degree is that just because you've executed better that you've managed the situation better?

Well, I think it comes down to a couple of things. Again, execution is key. But we also have strategic relationships with our suppliers. I mean, we buy most of our wafers from TSMC, right? So 3/4 of the business goes to TSMC. And so that's a huge strategic relationship for us and for them. And so we haven't really struggled with the supply shortages that others have seen. We're just that large. We're big enough to TSMC and we're large enough. And again, we're well managed, so that's all part of it.

And then do you see -- I mean we're hearing from your customers that they want to build buffer inventory. We're certainly seeing longer-term supply agreements on the balance sheet of some of your customers. How does that factor into the way you're managing this?

We also have long-term arrangements with our customers, too. I mean that's awesome to have. It's good. They use secure supply, they secure what they need. And so it all works out. I think I mean, again, we're not over shipping, and we work with our customers when it's needed.

Yes okay. Maybe if we could shift to the software strategy maybe big picture, going back to when it started. You were obviously -- there was a long phase at Broadcom where the company was acquisitive in the semiconductor space, obviously, LSI being one of those. And then more recently pivoted towards software, what is it that sort of has made that the more compelling vehicle for inorganic growth for you guys?

We've loved the software assets that we purchased. They've done well. I mean we've done well with them. I think it was a bit of a left turn for us at the time. I think people were scratching their heads, like what is Broadcom doing? We've done well with the acquisitions that we've done in the software space. The the key thing for us is to continue to be acquisitive that way.

And I mean, are the valuations not there on the semiconductor side to continue to grow organically in that direction?

No, that wasn't it so much. I think there's just been a lot of consolidation in the semiconductor space, right? So the targets that you would look at were just much, much larger. And in the software space, it's just a long list of companies. And we're super excited about the VMware acquisition that we hope to close in our fiscal 2023. That's going to be a terrific one, a terrific addition to the portfolio. We're very excited about it.

Okay. Great. And then maybe you could talk about Brocade versus software and maybe different results that you've seen there. Can you just talk to that disparity?

Sure. I mean the core software business, when we talk about -- let's back up. We talk about infrastructure software. What's in that mix is what we call core software, and then it's the Brocade business. The core software business is really CA and Symantec, those 2 software acquisitions that we have done historically. And then the rest is Brocade. Our core software business is really a subscription business model. It's a multiyear agreement arrangement, typically a 3-year duration. And we recognize revenue ratably in that business over time. It's a really sticky business, and you can see that in our consolidated renewal rates being over 120% year-on-year. We just reported that. When you look at our Brocade business, the Brocade business is a combination of hardware and software, and it is a really high niche market, fiber channel SAM business for large enterprises that want to build lossless networks. So super, super critical workloads work on this in this particular environment. And customers tend to buy in a more lumpy fashion, and that's why you can see Brocade ebb and flow quarter-to-quarter and year-over-year. But we do see it. It will strengthen as we go throughout the year. But nevertheless, it is -- it can be very lumpy, and that's just a reflection of the buying patterns.

Great. Let me pause there and see if we have questions from the audience. Do you have a microphone?

[indiscernible].

I completely understand what your question is. I can answer it. I understood your question.

Okay, and is there any possibility that you may have to divest of any product segments in order to get approval for the deal?

Certainly. The regulatory process is progressing positively. When a company -- Broadcom, when we sat down to think about this deal and the size of it, it's $61 billion. We knew that we would be in for, particularly in the political environment we're in. It would take a while to go through the process. So nothing is happening that we're surprised by, by any means. No, we would not divest of anything. We're not even at a stage where we would start discussing something like that, but that wouldn't even make sense to us. So the answer to that is it will close, it will close in our fiscal 2023, and nothing has surprised us so far.

Could you talk a little bit about what explains the remarkable margin performance that you've generated on the semi business and the improvement margins on the software business that you've acquired? You've been at a number of companies now. Talk about how Broadcom runs the business in a way that must be different than the way others run their business. Thank you.

Certainly. We focus on really good products, right, to our customers, providing value to our customers effectively. And we run a very tight supply chain process. And so the margins in our business are just a reflection of the cost to manufacturers, which we manage very tightly as well. And then the price that we're able to charge our customers effectively for the value that we're giving them in each of the products is effectively how that works.

Can you talk a little bit more about the role of price? I mean we've seen -- as foundry prices come up, everyone's been raising prices, but obviously, Broadcom has been very focused on kind of getting credit for the value that you're providing. Just how do you guys think about pricing over time?

Oh, no, we definitely, and we've talked about this publicly, I mean, as prices have increased to us, we've worked with our customers, and we have preserved our margins accordingly working with them, and we've had to increase our price as well. That's understood. That's part of our contracts. And again, if prices come down, we'll give it back. It's a strategic relationship.

Further questions from the audience? Maybe you could talk about the longer-term strategy for the cash flow that you're generating and how do you view the trade-offs between cash return. And from an M&A standpoint, would you sort of say that there are semiconductor opportunities that are out there that could someday be interesting, or is this kind of the path that you guys are charting?

We aren't partial to software semiconductor. It's the right asset that we're looking for. It's really -- we're looking for, again, market leaders that are long term and sustainable in the businesses that they're in. And I think that's available on the semiconductor side and the software side. We have a list that we keep working through. But the focus right now really is VMware. I mean that's pretty big, and we're so excited about it.

Great. All right. Is there any other question? All right. We'll go ahead and wrap up there.

Thank you.

Thank you so much. Appreciate it.