U.S. Markets closed

Edited Transcript of Broadcom Pte Ltd earnings conference call or presentation 15-Mar-18 9:00pm GMT

Q1 2018 Broadcom Ltd Earnings Call

Singapore Oct 12, 2018 (Thomson StreetEvents) -- Edited Transcript of Broadcom Pte Ltd earnings conference call or presentation Thursday, March 15, 2018 at 9:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Ashish Saran

* Hock E. Tan

Broadcom Inc. - CEO, President & Executive Director

* Thomas H. Krause

Broadcom Inc. - CFO & Secretary

================================================================================

Conference Call Participants

================================================================================

* Amit Jawaharlaz Daryanani

RBC Capital Markets, LLC, Research Division - Analyst

* Craig Matthew Hettenbach

Morgan Stanley, Research Division - VP

* Edward Francis Snyder

Charter Equity Research - MD and Principal Analyst

* Harlan Sur

JP Morgan Chase & Co, Research Division - Senior Analyst

* John William Pitzer

Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head

* Ross Clark Seymore

Deutsche Bank AG, Research Division - MD

* Stacy Aaron Rasgon

Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst

* Vivek Arya

BofA Merrill Lynch, Research Division - Director

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Welcome to Broadcom Limited's First Quarter Fiscal Year 2018 Financial Results Conference Call.

At this time, for opening remarks and introductions, I would like to turn the call over to Ashish Saran, Director of Investor Relations. Please go ahead, sir.

--------------------------------------------------------------------------------

Ashish Saran, [2]

--------------------------------------------------------------------------------

Thank you, operator, and good afternoon, everyone. Joining me today are Hock Tan, President and CEO; and Tom Krause, Chief Financial Officer of Broadcom Limited.

After market closed today, Broadcom distributed a press release and financial table describing our financial performance for the first quarter of fiscal year 2018. If you did not receive a copy, you may obtain the information from the Investors section of Broadcom's website at www.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 section of this call, Hock and Tom will be providing details of our first quarter fiscal year 2018 results, guidance for our second quarter of fiscal year 2018 and some commentary regarding the business environment. We will take questions after the end of our prepared comments.

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. 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.

At this time, I would like to turn the call over to Hock Tan. Hock?

--------------------------------------------------------------------------------

Hock E. Tan, Broadcom Inc. - CEO, President & Executive Director [3]

--------------------------------------------------------------------------------

Thank you, Ashish. Good afternoon, everyone. Well, we really had a very good start to our fiscal year 2018 with first quarter revenue and earnings towards the upper end of our guidance. First quarter revenue of $5.33 billion grew 28% year-on-year and 10% sequentially.

On the income front, earnings per share were $5.12, which grew 41% year-on-year and 12% sequentially. But please, just don't get too excited by this as Q1 was actually a 14-week quarter and do include -- did include partial quarter contribution from Brocade, which we closed during the quarter. But having said this, we do expect business conditions to remain favorable in our second quarter as well, although the revenue mix by segment will be quite dramatically different.

First quarter revenue, after adjusting for Brocade contribution, was all driven by wireless growth, while we expect the second quarter will be driven by double-digit growth of our other 3 segments, offsetting a very sharp seasonal decline in wireless. As a result, thanks to diversification, second quarter top line continued to be very stable.

Let's go deeper in the performance by segment, starting with wired infrastructure. In the first quarter, wired revenue was $1.88 billion, declining 10% year-on-year, 13% sequentially. And the wired segment represented 35% of our total revenue. As expected, first quarter wired results reflected the bottom of the seasonal decline in demand for both our set-top box and broadband carrier access products. The well-known weakness in optical access in metro end markets impacted us as well in this quarter. But in contrast, demand was strong from data centers, and cloud shipments remained stable.

Turning to the second quarter outlook fiscal 2018, however, we have a different picture as demand in this wired segment returned with a vengeance. We project strong double-digit sequential revenue growth, and this growth is driven by very strong increase in demand for networking products from cloud and data centers as well as the weighted seasonal recovery in broadband carrier access. Set-top box continued to be flat.

Now what happened in wired is in sharp contrast to wireless. In the first quarter, wireless revenue was $2.2 billion, growing 88% year-on-year and 23% sequentially. The wireless segment represented 41% of total revenue. First quarter 2018 wireless revenue growth was driven by the ramp of the next-generation platform from our large North American smartphone customer. As you may recall, this ramp was pushed out into the first quarter from the fourth quarter as compared to prior years. This push-up coupled with a very large increase in our content in this new platform drove the substantial year-on-year growth in revenue in the first quarter. But as we look into the second quarter of fiscal '18, we expect -- we are expecting a much larger-than-typical seasonal decline in wireless revenue as shipments to our North American smartphone customer will trend down sharply from the exaggerated first quarter. We expect to partially offset this decline from an increase in our product shipments that support a ramp of next-generation flagship phone in a large Korean smartphone customer. This phone also comes with an increase in Broadcom's wireless content on both our RF and WiFi/Bluetooth combo products. Notwithstanding such volatile seasonality, I should note that year-on-year, revenue growth for Q2 in this segment will still be in the double digits.

Turning to enterprise storage. In the first quarter 2018, enterprise storage revenue was $991 million and included approximately $330 million in partial quarter contribution from the recently acquired Brocade Fibre Channel Switch business. As reported, enterprise storage segment revenue grew 40% year-on-year and 54% sequentially. Without Brocade contribution, however, first quarter enterprise storage revenue would have resulted in flat but still stable performance sequentially. Storage segment represented 19% of our total revenue for the first quarter. Now the Brocade revenue in the quarter was actually higher than our prior expectation of $250 million, and this has been driven by stronger-than-expected demand of fiber channels and switches. Our server storage connectivity products also had a strong quarter with substantially increasing revenue driven by ramp in the Purley generation server shipments. And this growth, though, was partially offset by a decline in our hard drive -- hard disk drive business as demand bottomed out during the quarter.

Into the second quarter fiscal '18, the contrast here we expect to see is strong double-digit sequential growth in revenues in enterprise storage driven by robust demand from both enterprise and data centers.

Finally, industrial. First quarter, industrial segment revenue was $251 million and represented 5% of total revenue. Industrial product revenue remained very robust, grew by over 20% year-on-year. Resales also grew by 20% year-on-year and trended up 7% sequentially.

Looking into the second quarter, we expect strong double-digit sequential growth in industrial product revenue, and we continue to expect retail to trend up by the same amount.

In summary, therefore, for the first quarter, as we expected, we delivered very strong financial results and completed acquisition of Brocade during that period. Our second quarter fiscal '18 revenue outlook reflects the benefit of a very well-diversified product portfolio. We expect to fully offset the impact of a much higher-than-normal seasonal decline in wireless revenue with strong increases in our wired, storage and industrial segments. As a result, we expect second quarter revenue to be sequentially flat at $5 billion on a normalized 13-week basis for the quarter.

However, this change in -- the change in product mix will have a dramatic impact on second quarter gross margin, which we expect to sequentially expand by 100 to 150 basis points. Tom will provide more color during his guidance commentary on the impact this will have on our Q2 profitability.

With that, let me turn the call over to Tom for a more detailed review.

--------------------------------------------------------------------------------

Thomas H. Krause, Broadcom Inc. - CFO & Secretary [4]

--------------------------------------------------------------------------------

Thank you, Hock, and good afternoon, everyone. Our comments today will focus primarily on our non-GAAP results from continuing operations, unless otherwise specifically noted. A reconciliation of our GAAP and non-GAAP data is included with the earnings release issued today and is also available on our website at www.broadcom.com.

Let me quickly summarize our results for the first quarter of fiscal '18, focusing primarily on balance sheet and cash flow items. We delivered strong financial results for the first quarter starting with revenue of $5.33 billion, which was at the upper end of guidance. Our first quarter gross margin from continuing operations was 64.8%, 80 basis points above the midpoint of guidance as we benefited from a more favorable product mix in the quarter, driven by higher-than-expected revenue from the Brocade Fibre Channel SAN switches. Operating income from continuing operations for the quarter was $2.6 billion and represented 48.2% of net revenue. EBITDA from continuing operations for the quarter was approximately $2.7 billion and represented 50.6% of net revenue.

Our day sales outstanding are running on target at 45 days, a 1-day decrease from the prior quarter. Our inventory at the end of the first quarter was $1.3 billion, a decrease of $156 million from the prior quarter as we depleted wireless inventory we had built up to support the large ramp in first quarter shipments. We are pleased with this level of inventory going into the second quarter.

We generated $1.7 billion in operational cash flow, which reflected the impact in the first quarter of approximately $460 million in payments of annual employee bonuses for fiscal year '17; $240 million of cash, expended primarily on Brocade restructuring and acquisition-related activities; and an additional $129 million payment to fund the legacy pension plan. Capital expenditure in the first quarter was $220 million or 4.1% of net revenue.

Now let me turn to free cash flow, which we define as operating cash flow less CapEx. Free cash flow in the first quarter was $1.5 billion or 27.5% of net revenue and reflects the impacts of the items I just mentioned, including the annual bonus payout, restructuring and pension contribution. Without those items, I would just note, free cash flow as a percent of net revenue would have been 43%. As a housekeeping matter, I'd also note that CapEx was $94 million higher than depreciation in the quarter. We expect CapEx to continue to trend down and approach our long-term target of 3% of net revenue in the second half of fiscal '18.

We also continue to make significant progress in increasing our free cash flow per share. We calculate this metric as our free cash flow divided by the sum of our outstanding ordinary shares in limited partnership or LP units. For the first quarter of fiscal '18, free cash flow per share was $3.39 based on 410 million outstanding ordinary shares and 22 million LP units. More importantly, on a trailing 12-month basis, free cash flow per share for the period ended Q1 '18 was $13.79, an increase of 71% compared to the trailing 12-month period ended Q1 '17.

Now let me turn to our non-GAAP guidance for the second quarter of fiscal year '18. This guidance reflects our current assessment of business conditions, and we do not intend to update this guidance. This guidance is for results from continuing operations only.

Net revenue is expected to be $5 billion, plus or minus $75 million. Gross margin is expected to be 66%, plus or minus 1 percentage point. Operating expenses are estimated to be approximately $890 million. Tax provision is forecasted to be approximately $103 million. Net interest expense and other is expected to be approximately $114 million. The diluted share count forecast is for 461 million shares. The share-based compensation expense will be approximately $305 million. CapEx will be approximately $190 million. Our second quarter gross margin guidance anticipates a very favorable revenue mix driven by strong high-margin networking enterprise storage product sales and a more than seasonal decline in relatively lower-margin wireless product sales. Our guidance for second quarter operating expenses includes a full quarter of Brocade expenses and anticipates our typical increase in employee payroll taxes from the annual vesting of RSUs in the quarter.

Please note that after we complete redomiciliation to the United States, we presently expect our effective cash tax rate to be approximately 10%. We expect to start reflecting this new rate in our non-GAAP results starting with the third fiscal quarter of 2018.

In the second quarter, we are anticipating very healthy free cash flow and expect to deliver results above our target model of 40% of revenue.

Before we open the call for questions, I would like to briefly address this week's events. Yesterday, we announced that we have withdrawn and terminated our offer to acquire Qualcomm. We have also withdrawn our slate of independent director nominees for Qualcomm's 2018 Annual Meeting of Stockholders. Although we are disappointed with this outcome, we will comply with the order issued on Monday, March 12, 2018, regarding the proposed transaction. Importantly, we sincerely appreciate the overwhelming support we received from Qualcomm and Broadcom stockholders throughout these past few months. Indeed, I have to say we are touched by the ISS report issued just last night that continues to recommend the Broadcom independent nominees and by our understanding that based on the vote tally as of today, the 11 Qualcomm nominees are only garnering between 15% to 16% of the outstanding shares, not necessarily something to celebrate down in San Diego.

In any event, back to Broadcom. Consistent with our announcement in November to redomicile the company, we continue to believe the U.S. represents the best location from which to pursue our strategy going forward, and we don't see this week's events putting any constraints on our ability to pursue acquisitions more broadly going forward. To that end, we also announced that we continue to move forward with our redomiciliation to the U.S. and now expect to complete this process after the close of the market on April 4. This timing will allow us to hold our Annual Meeting of Shareholders on April 4 as presently scheduled. Our special meeting for stockholders to vote on the redomiciliation will still be held on March 23.

So with this, we know many of you are asking what's next. Hock and I have had the last couple of days to reflect on this. First, and most importantly, we remain focused on delivering superior return for our shareholders. Broadcom benefits from a long history of technology innovation, engineering excellence and product leadership across our 20 franchise businesses. We believe this will allow us to sustain mid-single-digit revenue growth and increasing operating and free cash flow margins. To reflect our confidence in the sustainability of the current business, we will continue targeting aggregate dividends of approximately 50% of free cash flow. This should afford us the opportunity to provide material dividend increases in the future.

The allocation of the remaining 50% of free cash flow is governed by the returns we believe that we can drive via acquisitions versus buying AVGO stock and/or paying down debt. As you all know, Hock and I are quite familiar with the industry landscape. And sitting here today, we do see potential targets that are consistent with our proven business model and that also can drive returns well in excess of what we otherwise achieve buying our own stock and/or paying down debt. If this view changes, rest assured we will not hesitate to change our approach. Providing superior returns for shareholders has been and always will be our focus.

One final point I want to make. Qualcomm was clearly a unique and very large acquisition opportunity. Given the maturity of the industry, the consolidation it is seeing and our relative size now, our future acquisitions are much more likely to be funded with cash available on our balance sheet and without the need to flex the balance sheet much beyond our current financial policy of 2x net leverage.

I would like to remind you that the purpose of today's call is to discuss our quarterly earnings. Consistent with our previous call, please keep your questions focused on today's financial results. We will not be commenting in Q&A on this week's events.

That concludes my prepared remarks. Operator, please open up the call for questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from Craig Hettenbach, Morgan Stanley.

--------------------------------------------------------------------------------

Craig Matthew Hettenbach, Morgan Stanley, Research Division - VP [2]

--------------------------------------------------------------------------------

Hock, can you talk about the strong rebound expected in the wired segment? I know you mentioned data center continues to be strong. Also, anything around kind of traditional enterprise? We're seeing some rebound in enterprise IT spending. And then how much that helps the segment a bit.

--------------------------------------------------------------------------------

Hock E. Tan, Broadcom Inc. - CEO, President & Executive Director [3]

--------------------------------------------------------------------------------

We've seen strength and we saw it, obviously, in bookings in Q1 for shipments in Q2. And we saw very large -- a very -- a lot of strength in both enterprise as well as cloud data centers in both respects. It's just strong, and it's strong across the full range of our networking products that I commented on. We also saw strong bookings which will translate into revenues, obviously, in Q2. Very strong revenue recovery in our broadband carrier access, which basically reflects DSL, digital subscriber lines, PON and attached enterprise and carrier WiFi. And that's typical seasonality, and it came back very, very strongly. What we don't see a sharp recovery is, obviously, fiber optics in networking. The old fiber optics out of data centers continue to be better -- not continue but has shown renewed strength. So basically, data center, cloud that are showing -- enterprise showing a lot of strength to offset, what I call, metro networks and, in our case, through a continued flatness in set-top box.

--------------------------------------------------------------------------------

Craig Matthew Hettenbach, Morgan Stanley, Research Division - VP [4]

--------------------------------------------------------------------------------

Got it. And then just a quick follow-up for Tom just on Brocade, the integration, just now that you have the business, kind of how you see it performing and then anything we should be aware of just from a margin perspective and as you take some costs out.

--------------------------------------------------------------------------------

Thomas H. Krause, Broadcom Inc. - CFO & Secretary [5]

--------------------------------------------------------------------------------

Yes. What we've been really pleased with Brocade, obviously, that's something that's been on the works for some time. And the business we were targeting there was the SAN switching business. It's continued to sustain as we had envisioned throughout not only the sign to close period but, obviously, has a very good start as part of Broadcom going forward. Clearly, it's a unique asset. From a financial standpoint as well, Craig, it's margin-accretive to the company. We see that continue to contribute positively to earnings and free cash flow. And frankly, to echo some of the comments I said in the prepared remarks, really reflects the kind of transactions we're looking to target going forward.

--------------------------------------------------------------------------------

Operator [6]

--------------------------------------------------------------------------------

And our next question comes from Ross Seymore with Deutsche Bank.

--------------------------------------------------------------------------------

Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [7]

--------------------------------------------------------------------------------

Hock, I just want to talk about the wireless business. I think everybody is pretty up-to-date on why the volatility both to the upside and then to the downside in the April quarter, given what your largest customer is doing. I wanted to think a little bit longer term. As we think about the rest of this year and next year, can you talk about what you see from a content perspective across the 2 components of your wireless business as well as from a market share perspective?

--------------------------------------------------------------------------------

Hock E. Tan, Broadcom Inc. - CEO, President & Executive Director [8]

--------------------------------------------------------------------------------

Well, a good point, I guess. Let's talk about content. And as I've articulated before, earlier, in previous calls, that view hasn't changed. On a sustained basis, I'll put it over the next 5 years, in the multiple sockets we have been which, as you know, represents both RF front-end, WiFi/Bluetooth combo chips in wireless connectivity and touch -- basically, touch -- phone touch and, to some extent, wireless charging as well, combined all together with those many sockets, on a sustained basis, over the next, I'll put, 3 years, possibly 5 years, we see that content sustaining growth in the teens, double digits. This has been the way it was for the last 5 years. And the trend was increased content. Whether it's 4G, 4.5G or 5G, we do not see that changing.

--------------------------------------------------------------------------------

Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [9]

--------------------------------------------------------------------------------

How about on the share side of things?

--------------------------------------------------------------------------------

Hock E. Tan, Broadcom Inc. - CEO, President & Executive Director [10]

--------------------------------------------------------------------------------

Okay. On the share side, I mean, I'd say it this way, we positioned the business we are in, and it's not just wireless, by the way, no differently in wired, enterprise storage and industrial. The core businesses, we called them franchises, that we are in, all 20 of them product lines, we pick them product lines, franchises to be businesses that we are very clearly out there in the lead, technology and market share and where we continue to invest a lot of money for further innovation for progressing technology. The bottom line to what I'm trying to get at is, in those businesses, what we worry about or what we have left to worry about are really ankle biters. And to be honest, ankle biters' biggest problem, they cannot bite above the ankle.

--------------------------------------------------------------------------------

Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [11]

--------------------------------------------------------------------------------

Okay. And I guess, as my follow-up question, one for you, Tom. You've made it pretty clear about the use of cash flow on the dividend side, the 50-50 split. But your commentary about what you may do with the other 50% gave a little more detail than we've heard in the past, and you included the phrase about paying down debt and share repurchases. Was that meant to be something that those are of increased probability? Or were you just kind of stating the obvious as far as potential uses of the other 50%?

--------------------------------------------------------------------------------

Thomas H. Krause, Broadcom Inc. - CFO & Secretary [12]

--------------------------------------------------------------------------------

No, I think, Ross, what it's trying to reinforce is that Hock and I are focused on doing what's in the best interest of shareholders. And we had the opportunity to reflect after this week's events on, obviously, the go-forward capital allocation strategy. And we feel, looking at the landscape, that the strategy we've had in place here for quite some time remains the strategy to drive those returns. And I think we want to maintain that we continue to be very focused on shareholder returns. And if that strategy no longer presents those type of returns, then we'll focus elsewhere.

--------------------------------------------------------------------------------

Operator [13]

--------------------------------------------------------------------------------

And our next question comes from Stacy Rasgon with Bernstein Research.

--------------------------------------------------------------------------------

Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [14]

--------------------------------------------------------------------------------

First, given the gross margin upside in Q2 on the heavy mix shift to the businesses, how should we be thinking about the drivers of gross margin into the second half of the year, given that, that mix shift that we're seeing into Q2 may be different as we move through the rest of the year? How is that going to influence you?

--------------------------------------------------------------------------------

Thomas H. Krause, Broadcom Inc. - CFO & Secretary [15]

--------------------------------------------------------------------------------

I'll take it. Look, I think there's a couple of things going on, both -- there's short term and then there's long term. Let me comment on both. Short term, when you look at the seasonality in the business over the fiscal year, obviously, the second half of the year is typically more wireless-weighted. Wireless, as everyone knows, tends to carry slightly lower than corporate gross margins. So I think I wouldn't get too excited in terms of where gross margins go from here through the end of this fiscal year. However, that being said, as you look longer term, consistent with the business model Hock has been driving the last 11 years, we continue to see content gains. We continue to have very good product leadership across the 20 franchise businesses. We've added Brocade, which is margin-accretive. So we don't see any reason, as I said in the prepared remarks, that as we sustain mid-single-digit revenue growth, you're not going to see leverage not only from an operating and free cash flow perspective but a lot of that's going to get driven by gross margin expansion. So we don't see any reason that, that can't continue.

--------------------------------------------------------------------------------

Hock E. Tan, Broadcom Inc. - CEO, President & Executive Director [16]

--------------------------------------------------------------------------------

And we have articulated in prior calls as far back as a couple of years ago that this business model we have put in place is one that, on an annualized basis, take it as something longer term, we tend to drive gross margin expansion around 100 basis points each year. We may be plus/minus 25 basis points, but year by year, if you look back several years, we have grown gross margin -- or we have expanded gross margin around 100 basis points. And we believe that trend still continues.

--------------------------------------------------------------------------------

Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [17]

--------------------------------------------------------------------------------

Got it. That's helpful. For my follow-up question, I just wanted to ask about sustainability of storage. So we're seeing some upside. You admitted Brocade was a little stronger than you had expected. And I think you've talked about this business like longer term, just given the drivers of the different segments within it being maybe flattish. But in reality, it's quite volatile. We have years where it's very strong and years where it's very weak. I know last year when we were seeing the strength in storage, you kind of warned us not to get too excited about the sustainability of that. How should we be thinking about the sustainability of that growth? And frankly, even in your other non-wireless segments as we're seeing that strong double-digit growth into Q2, how should we think about sustainability of that versus your long-term organic growth target?

--------------------------------------------------------------------------------

Thomas H. Krause, Broadcom Inc. - CFO & Secretary [18]

--------------------------------------------------------------------------------

Yes, so I think you got to unpack it a little bit, right, Stacy? So in the enterprise storage, we've got, obviously, the LSI businesses, the SaaS connectivity business, which is an absolute franchise. It is going to move from a cyclical standpoint with the Intel server platform releases. Obviously, we're in with Purley, we've had very good leadership position with the new products in that area and so that business is doing well, and we expect it to continue to do well this fiscal year. Contrast that with HDD. Obviously, HDD, we think, is in slight structural decline. We also have very good leadership position with those product lines. And so there has been more volatility than probably Hock and I would have anticipated in that business over the last several years. And I wouldn't think that would change, frankly, going forward as you look out. And then beyond that, Brocade. Frankly, Brocade's probably the one that's the most stable in our view. And of course, we've owned it the shortest period of time. But as you look forward, that's a business that we think can sustain at the levels that we saw on a full run rate basis in the first quarter. So we think, when you put all that together, I'd echo kind of where I think you are going, which is this is kind of a low single-digit type growth rate segment as we currently reported.

--------------------------------------------------------------------------------

Hock E. Tan, Broadcom Inc. - CEO, President & Executive Director [19]

--------------------------------------------------------------------------------

And to add to that, the last few years, what Tom is saying is the only volatile part of it is the hard disk drive business. And that's related -- for years, it has been there -- the whole enterprise storage business we see there, the various components are very, very stable, grow low single digit. Nothing exciting but very, very predictable and stable. What happened probably a year or 2 ago was flash coming in the picture and shortages and creating impact to the extent it creates impact, which is on the consumer client side of hard disk drive. And that creates some level of impact. Beyond -- as client goes down as a portion of the hard disk drive market and the data center part of the business expense, what we call nearline, you will see that volatility start to go away, too, and what you'll end up with then in our enterprise storage business as an extremely stable business, single-digit growth, if at all, but extremely profitable.

--------------------------------------------------------------------------------

Operator [20]

--------------------------------------------------------------------------------

And our next question comes from John Pitzer with Credit Suisse.

--------------------------------------------------------------------------------

John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [21]

--------------------------------------------------------------------------------

Hock, my first question goes back to the wired segment of January quarter. And this might be kind of a moot point just given how strong your April guidance has been. But I'm still trying to figure out that business being down 10% year-on-year. You characterized it as sort of a seasonal lull, but I would assume a year-over-year compare would catch that, and you did have the extra week this quarter that you didn't have last quarter. So I guess, I'm just trying to figure out what -- you mentioned a bunch of factors in your prepared comments. I'm trying to figure out what was the most significant factor. And as you think about the long-term growth in this business, to the extent that you'd have a 5% growth rate for the overall business, how does this business fit in? Because arguably, with your exposure to data center and cloud, this is probably the business that investors are willing to pay the highest multiple on, but it's one that, over the last several quarters, has actually been growing much slower than the other business unit. And I know there's a lot of different businesses inside of wired. But how would you think about the long-term growth rate and the moving parts on that?

--------------------------------------------------------------------------------

Hock E. Tan, Broadcom Inc. - CEO, President & Executive Director [22]

--------------------------------------------------------------------------------

Right. That's the best part of the question but to try to answer your technical part, which is what the hell happened in Q1 and all that. First, for the compare year-on-year-- if you compare year-on-year, which was Q1 a year ago, don't forget, what we did a year ago, there were some exceptional items, indeed, a year ago. What we did as part of the integration of classic Broadcom with Avago is we're able to dispose of certain assets. And as part of that, we sold manufacturing rights, which we articulated at that time we have announced the earnings, to certain companies out there for -- as part of the disposal process on overlapping products in the integration. And that jacked up the revenue artificial -- onetime a year ago. So we have that little compare to hit on. And the amount there wasn't small. It was over $60 million -- $60 million, $70 million. Small by a total spend of $2 billion but, nonetheless, it dealt a percentage and you worry about the 10%. So that's one thing I want to say to -- add on. But on Q1, to address your question on it, our wired infrastructure -- our wired business is really 2 parts when you look at it. One is data center, very much data center enterprise business, which is networking. And that's about just almost -- it's roughly half. And you have the other half, which is more carrier-related, operator service provider-related, which is really the set-top box business, the carrier access business and a part of our optics business, optical transceiver business, just as a part of optical transceiver that lands in data centers. And it's very interesting that the enterprise data -- and data center business, which was holding up in January quarter, but the other side was all down, all down, including optical that relates to fiber to the home to networks and operators, especially in China, and as well as carrier access, seasonally down, set-top box, seasonally down quarter. So we have one side being dramatically down; one side, holding up. Then comes April, and we see the part that's down a lot starts to recover quite strongly, especially in carrier access, popped right up. The fiber optics in China on networks and set-top box have not -- but that part of it popped up. But what we really start to see is also the other -- the half of the business in data center enterprise took on huge strain. A big part of it is some of the -- we start to ramp on some certain new products. I don't want to get into specifics which I had, you probably know what they are, they are networking and they are in AI, especially as well as various other programs all related to cloud and enterprise being very strong, and that's what drove this April strength. And that's kind of the whole story.

--------------------------------------------------------------------------------

John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [23]

--------------------------------------------------------------------------------

That's helpful, Hock. And then Tom, maybe as my follow-up, I think I understand the OpEx guidance going into the April quarter relative to period costs that come in on the payroll and Brocade. But I'm just kind of curious, given that you're going from a 14-week to a 13-week, how is that impacting sequential OpEx? I would've thought just having 1 less extra week would have helped you on the OpEx front? And how do we think about OpEx trending from April on to the second half of the year?

--------------------------------------------------------------------------------

Thomas H. Krause, Broadcom Inc. - CFO & Secretary [24]

--------------------------------------------------------------------------------

Yes, it's a good question. Look, we -- there's a lot of things going on. You've got the payroll uptick because of RSUs, which is material. You've got Brocade transition costs, which we have the benefit of having a longer time between sign and close, so we're very much actually past day 2 now and on our way to being fully integrated. So that should come off and bring numbers down. So as we look at the second half of the year, look, I would be thinking you're not going to see OpEx go up anymore, it probably does trend down slightly. But we're running at or about these levels when you exclude the Brocade transition expenses.

--------------------------------------------------------------------------------

Operator [25]

--------------------------------------------------------------------------------

And our next question comes from Vivek Arya with Bank of America Merrill Lynch.

--------------------------------------------------------------------------------

Vivek Arya, BofA Merrill Lynch, Research Division - Director [26]

--------------------------------------------------------------------------------

For the first one, Hock, I just wanted to go back to the prior line of question around wired segment. But maybe from a longer-term perspective, if you just set aside the seasonal aspects, what is the right way to think about a 2- to 3-year growth rate for the wired business? You obviously have strengthened your cloud switching and AI businesses, but is set-top box going to be a headwind longer-term? Just conceptually, do you think your wired business sort of grows in line, above or below your overall company 5% growth rate?

--------------------------------------------------------------------------------

Hock E. Tan, Broadcom Inc. - CEO, President & Executive Director [27]

--------------------------------------------------------------------------------

That is the one that will grow around 5%, and it's because -- I didn't finish the previous question totally, I do apologize. But to answer your question on that, remember, look at our wired business as 2 parts. One is enterprise data centers, which includes the switching. Basically, a lot of it is the switching. The controllers, routing, even part of routing, and even fiber optics that go to data centers. That area, we have been seeing, is growing very, very fast. There are occasional hiatus, flattening out, not going down but flattening out, as happened in January, as I indicated, even though demand continued to be good. But it keeps growing and it grows, I would say, close to probably -- on a year-on-year basis, probably close to 10%. Then we have the other side of business, which is more related to network service providers, and those are more volatile, more seasonal. But if you take it on an annualized basis, I would say it's practically flat. And that's why I'm saying that, on an average, something mid-single digits when you average out on an annual basis over a 5-year period, that it'd be running at that rate. It's very strong enterprise and cloud products, all enterprise and cloud, and there continues to be a lot of innovation in that areas, which we are right in the thick of, which we drive, in fact, a lot of it and which includes new applications, new ways to optimize data centers in cloud, less so in enterprise but definitely in cloud and associated. We have great fiber optics that ties to cloud computing and, against that, a more traditional but, nonetheless, very, very stable and sticky service provider wired business in the video delivery, set-top box, OTT as well and carrier access, which certainly provides both on end gateways especially for our carriers. So it's a mix of the 2 and the dynamics of the 2, but it's very clear that one -- a big part of the half is growing very fast, relatively speaking, and the other half doesn't grow.

--------------------------------------------------------------------------------

Vivek Arya, BofA Merrill Lynch, Research Division - Director [28]

--------------------------------------------------------------------------------

Got it. And for my follow-up, I appreciate that you want to talk about the earnings, but acquisitions have been a key part of your strategy longer term. And if I look at most of your targets, they have been sort of digital and larger companies. Are you open to also looking outside at perhaps analog or microcontroller assets? So without being specific about the targets, are there any pros and cons you can think off of looking at analog versus digital assets in the future?

--------------------------------------------------------------------------------

Thomas H. Krause, Broadcom Inc. - CFO & Secretary [29]

--------------------------------------------------------------------------------

Well, look, Vivek, obviously, we don't want to get into specifics. And I think what I would say to this is we're open, we're open to looking at anything that helps. One, that it's consistent with our business model, then, two, it's going to help us drive the kind of returns well in excess of our alternatives. So we've obviously shown openness. We obviously did Brocade, which is more of an appliance systems business but very consistent with our strategy and will remain that way going forward.

--------------------------------------------------------------------------------

Operator [30]

--------------------------------------------------------------------------------

And our next question comes from Amit Daryanani with RBC Capital Markets.

--------------------------------------------------------------------------------

Amit Jawaharlaz Daryanani, RBC Capital Markets, LLC, Research Division - Analyst [31]

--------------------------------------------------------------------------------

I guess 2 questions from me as well. On the wireless side, Hock, I think you talked about mid-teens content growth and not too worried about competition there. Wondering do you think pricing dynamics could be different in the industry as you go forward because 2 of your largest players, 2 of the biggest players in the industry, are really struggling to, I would say, drive unit growth at this point. So do you think pricing could be different as you go forward in this industry versus what you're seeing?

--------------------------------------------------------------------------------

Hock E. Tan, Broadcom Inc. - CEO, President & Executive Director [32]

--------------------------------------------------------------------------------

Well, you look at the phone dynamics, it's actually at the high-end flagship status, and make this -- you take the key assumption, which we do subtract to, that flagship status remains and continues to remain in the flagship status. Those phone makers, particular phone makers, have to innovate, have to offer features that continue to push their envelope. They're probably more mindful, as they will be, about costs, overall costs. But a lot of our components are not gimmicks, you realize. They are like basic, basic fundamentals to a phone working in various bandwidths. To give you an example of 5G, 5G adds on a lot more spectral bandwidth, which means you need more content, just simple basic fundamentals that -- going to 5G means you had to find new spectrum bandwidth to operate in. In every spectrum you'll find, you need more components in that direction. You need more bandwidth in wireless connectivity, you push in that direction, too. So yes, there will be. Now not necessarily every place, for instance, touchscreen, people might be cheaper and not push as much into it, we understand that. So that's a confluence -- a mix of both, which is why I say, on a long-term 5-year trend, the fundamental feature requirements will be what drive growth because you are running with more requirements in terms of performance even if it's as basic as operating in more spectral bandwidth as you go from 4G to 5G and on and on. And that alone by itself would drive, if you compute, that low -- at least low double-digit growth in content. There's no getting around it.

--------------------------------------------------------------------------------

Amit Jawaharlaz Daryanani, RBC Capital Markets, LLC, Research Division - Analyst [33]

--------------------------------------------------------------------------------

Got it. That's really helpful. And I guess, Tom, if I could follow up with you, you guys are doing 43%, 44% net income margins today. I think the free cash flow margin is about 1,600 basis points or so below that number. Structurally, at what point do you see these 2 things converging? And ideally, I would hope free cash flow margins improve, not the other way around. So when do you see that happening? When do you see these one-off things kind of abating away from you guys?

--------------------------------------------------------------------------------

Thomas H. Krause, Broadcom Inc. - CFO & Secretary [34]

--------------------------------------------------------------------------------

Well, I think it's happening. I mean, that was the point of sort of spelling it out for Q2, right? I mean, in Q1, you do have something that happens every year, which is we pay out our annual performance bonuses. And hopefully, we'll be able to continue to pay out the bonuses we've been paying out over the past many years going forward. So I'd expect that. But beyond that, the one-time items around the Brocade acquisition and the restructuring activities there as well as paying down the -- actually, one of the last legacy pensions we have where there's a liability, those are one-time items. So if you took those away, we're already running well above 40%, which is actually very much in line with non-GAAP net income. So we feel pretty good you're already seeing that conversion, especially as you look into Q2.

--------------------------------------------------------------------------------

Operator [35]

--------------------------------------------------------------------------------

And our next question comes from Harlan Sur with JPMorgan.

--------------------------------------------------------------------------------

Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [36]

--------------------------------------------------------------------------------

Great to see the diversification of the business playing out. You guys -- Hock, you provided a longer-term view on wired. Kind of more near term, looks like the double digits quarter-on-quarter growth in April is going to take you guys back to year-over-year growth. Given the trends that you're seeing, strong data center and cloud; you're ramping several new big ASIC programs; hopefully, kind of normal seasonal trends in broadband to the end of the year; second half, you'll be ramping Tomahawk 3, Jericho 2, but maybe still some headwinds on service provider. Net-net, do you expect full year fiscal '18, that your wired business is going to grow?

--------------------------------------------------------------------------------

Hock E. Tan, Broadcom Inc. - CEO, President & Executive Director [37]

--------------------------------------------------------------------------------

Oh, yes. Oh, yes, for sure. Our fiscal '18 compared to fiscal '17, we see our wired business growing, and we articulated that out, mid-single digits. There's quarterly up, quarterly down, capture all that, take it on an annual basis. It's just the trend on -- from enterprise but more on the net data centers, especially from the cloud, in pushing very hard for a lot more silicon products in those data centers. Bandwidth, they need more bandwidth. They need a set of pipes. They need offloading, as you said, [good but that is --] which means chips, controller chips that are getting very smart and things that grew things beyond what a standard CPU would do. I get all of these opportunities to take -- that drives this silicon growth in this area. Bandwidth alone is driving us to keep coming out with newer and newer generation faster and faster, by the way.

--------------------------------------------------------------------------------

Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [38]

--------------------------------------------------------------------------------

Great. And then the strength in the ASIC business has been highlighted over the past few calls, switching, routing, AI, deep learning. These are big complex digital chips, but you also have a pretty strong ASIC franchise in mixed-signal analog ASICs, things like human interface that's touch, 3D sensing, wireless power, power management. I hear that you guys' forward design win pipeline in this segment continues to be quite strong. Can you just talk about the differentiators that the team brings to the table here in mixed-signal analog ASICs that is keeping the pipeline pretty strong?

--------------------------------------------------------------------------------

Hock E. Tan, Broadcom Inc. - CEO, President & Executive Director [39]

--------------------------------------------------------------------------------

The core of it is, yes, our mixed-signal team. Or we call it the analog team in the digital age. We have one of the strongest, I call it, analog team in terms of DSP and converting analog, which is real-world signals, to digital in order for you to do organic stuff. Basically, ADCs, analog-to-digital converters, which is one of our key strengths, though we don't publicize it very much because that's what we do. We're very -- people see us as a very strong digital company, but you can't just do digital alone. What we have is, actually, one of the strongest analog-to-digital conversion capability in the world. And that has enabled us to do a lot of things very well hidden, in many ways, from the public eye. We can do a digital front-end ADC for even things like base stations, as an example. And we do that for human interface as part of our capability, and we do it for coherent receivers in DSP -- on a DSP basis. We do have a strong capability of people who, best way to describe it, virtually walk on water from the viewpoint of many of our customers. And that has enabled us to keep getting this strong backlog of programs that we are actively engaging in the various core business franchises we're in. This doesn't deviate us from our core franchises, I should mean -- I should say that, it just enables us to drive those core franchises deeper and deeper into performance, whether it be next-generation technology, whether it be driving 100Gs -- gigabits per second studies or driving ADCs that push the boundaries of where -- the extent of product technology driving -- send the products up and touchscreen controllers and various other things. So we see that as a useful tool capability towards continuing to sustain our leadership in those various core franchises we are in.

--------------------------------------------------------------------------------

Operator [40]

--------------------------------------------------------------------------------

And our last question comes from Edward Snyder with Charter Equity Research.

--------------------------------------------------------------------------------

Edward Francis Snyder, Charter Equity Research - MD and Principal Analyst [41]

--------------------------------------------------------------------------------

Hock, the comment you just made here is actually in line with what I was going to ask you about your core franchises. You've got these franchises, you've been articulate about where you're going to go, where you don't go. But there seems to be this other area, the custom ASIC area, you did router for Cisco years ago and then you've gotten into AI and then when your largest customer, when you got Broadcom, you obviously moved into connectivity but you also jumped into areas that would be considered unnormal for Broadcom, Avago even, like wireless charging, which the market itself is really way below where your margin profile exists, but you've done a really good job of that. So I know it's not a franchise, but isn't it the case that your custom ASIC business is becoming kind of a franchise unto itself with a select groups of customers where you can go in and do things they can't do and offer them a service? If that's the case, what are the boundaries in terms of what you can and can't do in that kind of a franchise?

--------------------------------------------------------------------------------

Hock E. Tan, Broadcom Inc. - CEO, President & Executive Director [42]

--------------------------------------------------------------------------------

Ed, that's very, very insightful and perceptive question. You're right. We have something to see there and we are very careful, but we have been asked by -- I mean, some of it, of course, we go dig it out ourselves. But in some cases, certain customers who need technology that pushes the envelope like no speeds of -- the accuracy and speeds of ADCs, for instance, we've been asked by certain customers into areas beyond what we have touched on. And I also mentioned that on the ADC on the front-end, a DFE or base stations as an example where we've been approached by customers to design its CMOS silicon what used to take non-CMOS processes to do and be able to achieve the same performance with much lower power and potential integration possibility. All that comes in. And you're right, we don't know where the limits are, but we're very careful that we do not expend resources in the wrong manner back to ROI, as Tom said. Every dollar or every resource we put into a program, we are very conservative, very risk-adverse, you might say, about ensuring we get a very good ROI. And that comes in making sure customers put skin in the game together with us when they ask us to do programs where we are expected to, as I keep saying, walk on water literally. We want to make sure that we get a high probability of a good ROI in doing that. But it goes to enhance our overall business model of franchises in business, in the various end markets we are very, very good at.

--------------------------------------------------------------------------------

Edward Francis Snyder, Charter Equity Research - MD and Principal Analyst [43]

--------------------------------------------------------------------------------

So is it safe to say in that kind of context then because the feedback we've gotten was that, I believe, it does sound like you guys do an exceptional job in terms of delivering on time and performance they didn't think they could get? But it leads to a puzzle then because I would've never expected you to get into some areas that you've moved into like wireless charging, for example, it's more analog and much more lower margin. Is it the case that once you start engaging with these customers, like you're the internal custom ASIC group, that they'll start throwing problems to you and say, "Can you do this?" And so it opens up a much wider swath of technologies that you could go into if the agreement is cast correctly so that we may be seeing you do stuff that may be more uncharacteristic if you haven't had the custom ASIC group?

--------------------------------------------------------------------------------

Hock E. Tan, Broadcom Inc. - CEO, President & Executive Director [44]

--------------------------------------------------------------------------------

Ed, again, very insightful, and we see that. I'll just say we're very disciplined, extremely disciplined. Just like the way we do our acquisitions, recent example excepted. Just kidding. But typically, we are very, very disciplined. And here, in the use of resources, in developing a program that is outside what we consider to be franchise areas, core areas, we will be very, very careful and very, very disciplined. We don't take everything thrown in our direction.

--------------------------------------------------------------------------------

Operator [45]

--------------------------------------------------------------------------------

Thank you. That concludes Broadcom's conference call for today. You may now disconnect.