Broadcom Inc.

Good day, ladies and gentlemen, and welcome to the Q2 2019 Broadcom Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference is being recorded. I would now like to introduce your host for today's call, Ms. Beatrice Rosado. Director, Investor Relations. Ms. Rosado, you may begin.

Thank you, Operator, and good afternoon, everyone. Joining me today are Hop Tan, President and CEO, and Tom Krause, Chief Financial Officer of Broadcom. After the market closed today, Broadcom distributed a press release and financial tables describing our financial performance for the second quarter of fiscal year 2019. 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 investor section of our website at broadcom.com. During the prepared comments section of this call, Hawk and Tom will be providing details of our second quarter fiscal year 2019 results guidance for fiscal year 2019, and commentary regarding the business environment. We will 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. So with that, I'll now turn the call over to Hawk.

Thank you, Bea, and thank you, everyone, for joining in today. Let me touch on the second quarter results, after which I will update you on the current environment and our outlook for the second half of the year. Looking at the second quarter just passed, it really went as planned. Networking continued to perform very well and our broadband business started to recover. This was offset by the anticipated sharp decline in wireless and the ongoing softness in storage. On the other hand, The infrastructure software business delivered solid top-line results, benefiting from sustained enterprise demand for mainframe and distributed software, as well as SAN switching products. The integration of CA is progressing well. Just last week, we reached a major milestone with day two. which is the integration of the CA's business processes onto Broadcom's IT platform. We remain confident that we can meet, if not exceed, the long-term revenue and profitability targets that we laid out for CA2U last year. Renewals in our CA business are strong, and the dollar commitments from our core customers continue to grow. Now, let me address the current business environment and our outlook for the remainder of the year. We have, as I indicated, performed very much to plan in the first half of fiscal 19. And in the second half, we had expected a recovery. While enterprise and mainframe software demand remains stable, particularly in North America and Europe, with respect to semiconductors, it is clear that the US-China trade conflict, including the Huawei export ban, is creating economic and political uncertainty and reducing visibility for global OEM customers. As a result, demand volatility has increased and our customers are actively reducing inventory levels to manage risk. This leads us to believe the second half of 2019 will be more in line with the first half as opposed to the previously expected recovery. We now anticipate fiscal 2019 semiconductor solutions segment revenue of $17.5 billion, which translates into a year-over-year decline in the high single digits. CAA software continues to perform above original expectations, while SAN switching is slowing down after a very strong first half. As a result, we are maintaining our fiscal 2019 infrastructure software outlook at $5 billion. While this scenario has been playing out, I should emphasize the fundamentals of our business remains very much intact. We continue to execute on a very rich roadmap for next-generation network switching and routing in the cloud and enterprises, including the leading-edge Trident 4 software-defined network switch just recently announced this week. We've also secured the next two generations of RF front end and a large North American OEM, which positions us very well for the transition into 5G. We continue to win increasing numbers of compute offload accelerators in the hypercloud operators across AI, video transcoding, encryption, and networking. We are pleased with the RAM of our new generation Wi-Fi 802.11ax, otherwise called Wi-Fi 6. in enterprise gateways and carrier access points. All this leaves us confident that we will be able to continue to drive sustained long-term revenue growth and increasing free cash flow. Let me now turn it over to Tom, who will provide you with more color.

Thank you, Hart. Consolidated net revenue for the second quarter was $5.5 billion, a 10% increase from a year ago. EPS came in at $5.21, a 7% increase from a year ago off of a $448 million weighted average for the diluted share count. In addition, we had record free cash flow of $2.54 billion or 46% of revenue. Free cash flow grew 20% year-over-year. The semiconductor solution segment revenue was $4.1 billion and represented 74% of our total revenue this quarter. This was down 10% as expected year on year on a comparable basis. Our infrastructure software segment revenue was $1.4 billion and represented 26% of revenue. Let me now provide additional detail on our financial performance. Operating expenses were $1.02 billion Operating income from continuing operations was 2.95 billion and represented 53.5% of net revenue. Adjusted EBITDA was 3.11 billion and represented 56.4% of net revenue. This figure excludes 142 million of depreciation. Receivables in the quarter decreased 193 million and inventory decreased 40 million from the prior quarter. I would also note that we accrued $136 million of restructuring and integration expenses and made $218 million of cash restructuring and integration payments in the quarter. Finally, we spent $125 million on capital expenditures. In the second quarter, we returned $2.4 billion to stockholders consisting of $1.1 billion in the form of cash dividends and $1.3 billion for the repurchase and elimination of 4.7 million ABGO shares. We ended the quarter with $5.3 billion of cash, $37.5 billion of total debt, $399 million outstanding shares, and $447 million fully diluted shares outstanding. We also refinanced our $18 billion of term loans that we put in place at the beginning of fiscal 2019 to finance the CA acquisition. Via a combination of $11 billion of investment-grade bonds and a new term loan, we were able to extend our average debt maturity to approximately five years and substantially reduce the corner debt due in any one year. As of today, our average cost of borrowing stands at approximately 3.7%. Turning to our fiscal year 2019 guidance. As Hawk discussed, we are updating our full-year revenue guidance to $22.5 billion, including approximately $17.5 billion from semiconductor solutions, and approximately $5 billion from infrastructure software. IP licensing is not expected to generate a material amount of revenue. On a non-GAAP basis, operating margins are expected to be approximately 52.5%, an increase of approximately 150 basis points from prior guidance. Net interest expense and others expect to be approximately $1.3 billion. We do not contemplate any debt pay down in fiscal year 2019. The tax rate is forecast to be approximately 11%. Depreciation is expected to be approximately $600 million. CapEx is expected to be approximately $500 million. As a result, free cash flow is expected to be approximately $9 billion, which takes into account projected restructuring and immigration charges of approximately $1.1 billion. Stock-based compensation expense is expected to be approximately $2.2 billion. And finally, we expect weighted average diluted share cap to be $444 million for Q3 and $443 million for Q4, and this excludes any impact from share buybacks and eliminations. Now on to capital allocation. Our capital allocation strategy remains the same. We plan to maintain the current quarterly dividend payout of $2.65 per share throughout the year, subject to quarterly board approval. which means we plan to pay out over $4 billion in cash dividends in fiscal 2019. In addition, we remain committed to buying back and eliminating a total of $8 billion of stock in fiscal 2019. In the first half of the fiscal year, we have spent $4.8 billion for the repurchase and elimination of shares. That concludes my prepared remarks. During the Q&A portion of today's call, please limit yourself to one question each so we can accommodate as many analysts as possible. Operator, please open up the call for questions.

Thank you. Ladies and gentlemen, if you have a question at this time, please press the star then 1 key on your touch-tone telephone. Again, we ask that you please limit yourself to one question. Our first question comes from Vivek Arya with Bank of America.

Thanks for taking my question. How can the $2 billion or so reduction in the semiconductor outlook for the next two quarters Can you give us some sense how much of that is Huawei, how much is outside of Huawei, and just any segment-level impact so we can calibrate our models? Thank you.

Well, it's an interesting way to figure that out because in terms of full disclosure, Huawei represented last year about $900 million of revenues for this company. by itself. But the other side of the picture I should add is that guide down that we're providing, as you put it, of $2 billion obviously extends beyond just one particular customer. We're talking about uncertainty in our marketplace, uncertainty because of that of demand in the form of order reduction as the supply chain out there constricts, compressed, so to speak. And because we do see, to some extent, end user in the U.S., particularly North America and Europe, continuing to be there. But what we do see in between is the uncertainty of the environment has put in place concern about placing additional orders, and actively a reduction of inventory out there. Basically, a compression of supply chain is what's driving this reduction more than anything else. And it's broad-based.

Thank you. Our next question comes from Blaine Curtis with Berkley's.

Hey, guys. Thanks for that question. Maybe I can just follow up on the next question. I'm just kind of curious as you look. I mean, I think markets were soft and you saw a lot of revisions last quarter. You guys kind of maintain your forecast. I'm kind of just trying to figure out when you saw this slowdown. I can give us any idea of that. And then is there just any more color you can add per end market? Is there any end markets that you're not seeing this weakness? And if you can point to any particular products, that would be helpful.

Well, We started seeing this softness right as we basically at the beginning of this quarter, right in Q3, very much so, and dramatic reduction, and it particularly accelerated with the denial order that was imposed on Huawei.

Thank you. Our next question comes from Harlan Sir with JP Morgan.

Good afternoon. Thanks for taking the question. On the networking side specifically, you know, that's been a strong area for the team going double digits year over year for the past few quarters. And it's an area where you guys actually do have some pretty strong product cycles like Tomahawk 3, Jericho 2, some of the compute offload ASICs. In your revised outlook, ex-Huawei, How is the macro uncertainty impacting this segment and some of these programs? And again, ex-Huawei, would you expect a networking business to grow second half over first half?

A very good question. Our networking business, which I think is what you're referring to, continues to be a very strong business. Year on year, we expect our networking, total networking business to grow double digits year on year. It's strong, particularly with new product ramps and new product cycles that we're seeing both in switching, routing, related to that. It is one of the brightest areas in our portfolio in this environment and continues to be strong, notwithstanding the export ban on Huawei.

Thank you. Our next question comes from Ross Seymour with Deutsche Bank.

Hi, Hawk. Thanks for letting me ask you a question. I wanted to go into the wireless side. I know you just signed a supply agreement with a large North American customer. They typically have positive second-half seasonality, and most of us believe you actually were regaining some share. So I put that all into the mix. How are you getting, especially given what you just said in networking growing double digits, How are you getting the second half to be relatively flat with the first half? Is there some offsets in other areas, or are some of our assumptions in wireless incorrect?

Well, I don't know what the assumptions are also on wireless, but networking is about really the only area of strength in this current environment, and that's because it coincides with very strong product cycles we're seeing In just about broadly any of the end market segments, we do not see in terms of year on year improvement from 2018.

Thank you. Our next question comes from Timothy Arcuri with UBS.

Hi. I just had a, you know, question about the competitive environment for your RF front end business as we, you know, kind of move into 5G. and particularly around a, you know, large modem maker now that's, you know, talking about having a complete RF package and sort of being able to sweep that in with their modem. So can you kind of talk about the, you know, competitive environment and your position as you kind of get into 5G? Thanks.

Oh, that's a very interesting question. We continue to believe we are very, very strongly positioned and in many ways validated by some of the data points I just mentioned. We have by far the best technology and products out there in RF front-end components, that's typically the filters and the integrated front-end modules. We are by far the furthest ahead technology-wise and in terms of capabilities, and we continue to believe we are still very much in front. And as I said, it's been validated and continues to be validated by the value we give to our very critical customers and the fact that they continue to be very supportive of our business.

Thank you. Our next question comes from Toshi Hayahari with Goldman Sachs.

Hi, guys. Thanks for taking the question. I had a question on RF as well. Todd, can you remind us what kind of content growth are you expecting or assuming into the back half, both on the RF side as well as the Wi-Fi side of your business within wireless? And then you also talked about 5G. or rather how the recent wind positions you well into 5G. As of today, what you know based on what you've heard from your customers, what kind of content growth on the RF side are you expecting as we transition to 5G over the next couple of years? Thank you.

Thank you. Well, you know, asking year on year is actually very difficult, so I appreciate you asking me what do I see over the next two, three years on content growth. I mean, the best way to describe content growth in RF, and we've seen that, we have empirical evidence of that for the last five years, even longer, and not the same every year, is that annually we probably see in the 5% to 10% range content growth. And in terms of the products we ship. Now, for the entire, I guess, available market, it's probably a smaller growth percentage.

Thank you. Our next question comes from John Pitzer with Credit Suisse.

Yeah, good afternoon, guys. I just want to go back to Ross's question about the wireless guide for the balance of the year. I'm just curious, relative to 90 days ago, when you guys were kind of guiding the overall semi-business well above normal seasonality for the balance of the year. Now you're talking about a flat half to half. To what extent did your content expectations come down for the back half of the year versus just this really being a unit issue on the wireless side of the business?

Well, that's an interesting question that lays out that way. Keep in mind, we're taking a very conservative stance here. And very frankly, even as we see the ramp up, and we do see the ramp up, we have also been forecasting a fairly dramatic set of numbers before. And that is more than offset by the fact that for the rest of the broader market, we're just seeing the main environment, that is extremely unfortunate.

Thank you. Our next question comes from Craig Hettenbach with Morgan Stanley.

Yes, thanks. I'm just coming back to the compute offload you talked about at hyperscale. I know a little while back you guys talked about some initial traction ASICs. Just wanted to get an update in terms of the breadth of that at particular hyperscalers and how you know, to the extent that you're extending that to multiple customers as we look forward?

Well, I have mentioned before in previous calls, earnings calls, about our focus in increasing traction in what we call compute offload engines, or I call it compute offload accelerators in multiple areas, including AI, of course, and virtualization orchestration from the compute servers and extending that now to video transcoding and encryption, and we continue to see that. And it is an emerging space from our perspective, but nonetheless, it's a space that seems to be growing very steadily and continuing to trend now very significantly. And this is a space we believe at the end in matter of three to five years could be a significant percentage of a total compute span within any large-scale data center. And we're talking about potentially getting to perhaps even as high as 25% or more. of total spend in the computing environment of a large-scale cloud data center.

Thank you. Our next question comes from Chris Stanley with Citi.

Hey, thanks, guys. Just looking at the overall environment, do you think your guidance incorporates the, you know, proposed next round of $300 billion in tariffs, i.e., if that thing does go through, do you still feel good about your guidance, or do you think there could be more downside if it does go through?

I think at this point, we try to capture everything, including that proposed next round, into the picture. We have the belief that things are, environment is very, very nervous. And that's why we see a very, very sharp and rapid contraction of supply chain and orders out there from our customers, especially our global OEM customers. Even as we believe, as I mentioned, in North America and Europe, end demand hasn't reflected there. So we are seeing a very reactive mode here. And so I got to believe that includes the sense that this 300 billion of next round potential tariffs could be in place. Also keep in mind something I should add is that even as we see some, you know, there are two parts to this. One part is what's the impact of the Huawei ban on a company like us selling components and technology? Well, short-term, keep in mind, we'll see a very sharp impact simply because there are no purchases allowed and there's no obvious substitution in place from other OEMs replace taking over and demand which may exist, which may continue to exist. Give it a few months. Give it six months. If those end demand still remains out there, we'll see other OEMs qualified to take over those, to replace Huawei on those demand. And other OEMs will come in, and those OEMs will continue to buy our products. And so we have a rebalancing and readjustment in demand from our side. But short term, we do not expect to see that.

Thank you. Our next question comes from William Stein with SunTrust.

Great. Thanks for taking my question. On a brighter note, I'd like to ask about CA a little bit. Last quarter, Hawk, I think you talked about at least one proof point with regard to sort of deeper engagements with CIOs around a deal that might involve both sides of the business. Anything similar to that where you've seen more proof of points More proof points around traction and in sort of the strategic approach in that acquisition.

Thank you Well, yes, one of the things we are doing is as we said last time is as We focus on core accounts as I say, these are the largest enterprises in the world buys a lot of software infrastructure and infrastructure software and And given the broad portfolio of products CAA has that we bring to bear between mainframes and these largest companies mostly runs a lot of mainframe capacity and distributed software in infrastructure and our ability to offer this as an enterprise and portfolio-wide transaction, we've been very, very successful in securing such enterprise-wide contracts with significant uplift in booking dollars in the form of larger amount of renewals with, right now, over 20 large accounts in the six months since we've taken over and closed on this transaction. And we foresee that rate been even higher over the next six months. So that's working, and that's working very well, which allows us to give you a fairly positive tone to how the CA business has been trending as far as we're concerned. Putting it in a nutshell, and I said that earlier, the amount of dollar commitments we've been able to achieve compared to what expires has increased quite significantly.

Thank you. Our next question comes from Matt Ramsey with Cowen.

Thank you very much. Good afternoon. Hock, I wanted to ask a little bit about, obviously we talked about the demand environment and the trade environment a bit, but I wanted to ask a little bit about the M&A environment as you see it. Obviously, CAA took the company in a little bit of a different direction, but we've seen some semiconductor mergers announced here very recently, and I wonder if you might give us a little bit of a view on the M&A environment as you see it right now on the semiconductor side.

Thank you. Oh, you're saying the M&A environment in the semiconductor space? Yeah, I see what you see there, which is some level of activity that seems to go on. And it's quite interesting in a way, quite encouraging for us to see that the direction we're taking a large part of this industry seems to be making sense to a lot of our peers too. And from our point of view, we welcome it. And as I've indicated before in previous earnings call, for us it's what makes sense, what's in terms of, you know, businesses that are franchises that we see as very sustainable and that are, that we are able to acquire. And, but right now, you see a lot of movements, but we, and we are very, we continue to be very interested in opportunities that may present themselves, and we continue to be very active in assessing those opportunities.

Thank you. And our final question will come from Chris Caso with Raymond James.

Yes, thank you. Haka, I just wanted to return to some of your questions, some of your comments, rather, regarding inventory. And you talked about the customers reducing inventory. Do you think that the inventory levels of the customers were elevated coming into the quarter, or is this just a situation where the customers are reducing inventory proactively because of the the uncertainty? I guess the question is how much of the, you know, the weakness you see here is driven by inventory reductions as opposed to demand?

I think what we're seeing a lot here, because overall demand weakness or uncertainty probably started even before this quarter began, but the sharpness in terms of demand contraction, demand reduction, as you say, is coming from the fact that customers are even more aggressively now trying to reduce inventory out there. And a lot of it is customer inventory that we're talking about directly. As you notice on our balance sheet, our inventory has been very well managed, tightly managed, And we continue to be very, very consistent through all this in the range of 65 days of inventory. So this reduction is very much an action of the supply chain of the end user, which really reflects on our direct customers, where there's been a sharp reduction of inventory out there. And are we talking significant? Yeah, we believe it is. What we've seen is very significant, and we anticipate that to continue, which reflects in our revised guidance for the rest of this year, which is the next less than six months out there. Beyond that, who knows?

Thank you. Ladies and gentlemen, thank you for participating in today's Q&A session as well as today's conference call. This concludes the program. You may all disconnect and have a wonderful day.