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Broadcom Corporation (NASDAQ:BRCM)

2014 Morgan Stanley Technology, Media and Telecom Conference Call

March 04, 2014 04:30 PM ET

Executives

Eric Brandt - Chief Financial Officer

Chris Zegarelli - Director, Investor Relations

Analysts

Joe Moore - Morgan Stanley

Joe Moore - Morgan Stanley

Alright. Good afternoon. I am Joe Moore. Welcome back after lunch. I am happy to have with us today Eric Brandt, CFO of Broadcom as well as Chris Zegarelli, Director of Investor Relations. Thanks guys.

Eric Brandt

Thank you.

Chris Zegarelli

Thank you.

Question-and-Answer Session

Joe Moore - Morgan Stanley

So maybe we can just start out, bigger picture, I look at your business is having something close to $2.50 in earnings power with no contribution from mobile and wireless, $4 in cash. I mean I feel like you are getting basically no credit for the mobile and wireless business which I think has some value. Am I being too simplistic when I think of it that way?

Eric Brandt

I think you are probably thinking about it the way a lot of investors do. I think it’s in a show me mode and people are wait and see. So, as a result, get much value until you can prove, you can drive value on the mobile side. I think on the connectivity side, there has always been a fair amount of headline concern. But net-net, the business continues to perform, does well, good margin business. So I think it’s an important year for us; it’s an important opportunity for us to prove that we can deliver on the mobile side and generate the kind of economics that are attractive and to extent that they’re not then take the appropriate action.

Joe Moore - Morgan Stanley

Okay. Maybe we could start off looking at the networking business a little bit and then kind of move to the mobile and wireless, which is more controversial. But you guys grew 12% last year, 35 points of operating margin in the fourth quarter, obviously a very good period for networking and infrastructure. Can you talk about what’s driving that growth and where you think the key drivers are this year because the end market environment has been just sort of okay and you guys have been doing pretty well?

Eric Brandt

Yes, I think people focused a lot on the end market environment as exposure to the enterprise. I think to the extent that you’re well exposed to the data center and cloud side of the market which we are on the switching side, we benefited from that, we’ve had a good product cycle with the Trident family and other products, our switch fabric product et cetera. And as a result, we have benefited over the course of the year and seen steady growth over the course of the year. Simultaneously, I would say that the service provider market has been okay, it’s not been horrible. But data center has probably moved from low to mid-20s to mid-30s in terms of the mix of our business and I think that’s high end, high value, high revenue generating opportunities for us.

And the reason why you see the operating margin expand as we’ve said in the past is that this is a business which is highly leveraged to revenue growth, particularly when you manage your cost structure fairly tightly, and you’ve seen substantial expansion in the operating margin from probably mid-20s to mid-30s over that time period.

Joe Moore - Morgan Stanley

Great. And do you think the service provider business which had been lumpier; I mean do you expect that to kick in over the course of 2014?

Eric Brandt

Hard to say, I think that every time there is sort of a slight move, people sort of declare it a bottom and it’s turned. I think it’s not bad, I would say Europe’s a little bit lagging behind, China is beginning to pick up, U.S. is sort of in the middle, I would say between the two. I would say the good news for us is that as our footprint broadens in terms of what we offer on the service provider side to extent that there is any pick up on that, we benefit from it as well.

Joe Moore - Morgan Stanley

Okay, great. And you had some nice announcements at Mobile World Congress around small cell deployments; can you talk about that business, how much you’re investing and when do we see that?

Eric Brandt

Yes. Small cells are being run out of our broadband group, actually doing quite well. We’ve had a number of design wins. We did very well with the first generation chip; we’re now on the second generation chip, lots of interest. Virtually all of the carriers and service providers, not quite all but almost all are in some form or fashion looking at our product line. So, I would say we’re quite pleased, a lot of traffic and boost around that product, and I would say cautiously optimistic.

Joe Moore - Morgan Stanley

Okay, great. And then you also had an announcement recently that you’re divesting small amount of even net assets to QLogic. I don’t normally think of Broadcom being a seller of businesses, so can you talk about what led to that?

Eric Brandt

Yes, I think it’s a good proxy or indicator of the way we consider our portfolio and manage our portfolio and the fact that the portfolio processes we do at a corporate level transcend the corporate level into the business unit level. This is a situation where the person who ran the infrastructure business regime did his own portfolio analysis wanting to focus his investment on the data center side and doing end-to-end was concerned about the product roadmap and the transition, he refocused his resources to another part of the business. I think we’re fortunate in having an opportunity as part of this portfolio process to actually sell that business to QLogic, partition it. We continue to participate in the economics of that business through ASIC relationship. So, I think for all parties involved, it was win-win.

Joe Moore - Morgan Stanley

Okay, great. And then your broadband business, you grew a bit last year also very good operating margin, 24%. Can you talk about the long-term expectations for that business?

Eric Brandt

Yes. Look, broadband is a good business, last year was particularly strong on the set-top box side, picked up, outgrew its peers probably overall in broadband by double-digits. So continuing to see benefit on geographic expansion, going after a number of the geographies where we really haven’t participated, further in Latin America, beginning to at Africa, Eastern Europe, Russia, et cetera. And I think, we’re benefiting from that. Couple that with increased content, devices with more tuners, UltraHD, HEVC, a variety of different things. And so what’s happened is broadband has continued to outgrow its market and continue to grow in a market where -- they probably do low to mid single-digits growth in a market that’s been relatively flat form a sub perspective. And I think it’s a combination of product and geographic expansion.

Joe Moore - Morgan Stanley

Okay, great. I am going to spend most of the time on mobile and wireless because I think that’s the -- where I get 90% of the questions, I think most people recognize the value inherent in the other two segments. Within mobile and wireless, can you just talk big picture about, I mean you have a good connectivity business that’s generating a lot of margin with maybe some market share threats to it as well as a big baseband investment that’s using up a lot of those profits. How do you think of those things intend, do you need the baseband’s access to maintain the connectivity business?

Eric Brandt

I think you have to think about it in segments. At the highest segment, I think those products are sold based on feature and functionality, and feature and functionality of being in the baseband business or a platform sell probably not particularly important. It’s really the quality of the product and the experience that’s transferred to the user with that product. And so we showed on Analyst Day twice the throughput, half the power consumption on our connectivity.

If you look at the middle part of the market of the smartphone market, I would say that’s a little bit more of a battle ground sort of going back and forth. And I think you see a little bit more headlines. And there are some opportunities where people sort of trump at particular win and then we go back and we win the win. And so -- and you will see some of those towards the back half of this year, we’ve gone back and won a couple of different things.

On the low-end of the market and that’s where I think last year you saw most of the growth on low-end of smartphones, those really are a platform sell. And so to the extent that you are not in the baseband part of that business you are not going to sell the connectivity.

And so for what I would consider the highest most attractive part of the market not as important on the lower-end of the market where there is pull-through and the importance of having a full platform for the customer it does become important.

Joe Moore - Morgan Stanley

I mean it’s kind of interesting because last year there were so much focus on every socket that you loss and yet your retention of the big flagship sockets was extremely high. You talked about having connectivity growth this year at the Analyst Day when you reported -- and you haven’t said which socket you have, but it’s hard enough now to get there if you don’t retain most of those flagship sockets. So I mean is that something where you think you keep those for years or for this year or I mean how should we think?

Eric Brandt

Well, this is the only as good as what you did the last time and we have probably reasonable visibility out for about six to nine months or so of the designs that are coming to market and where we are. And if you don’t innovate you don’t continue to drive the value in those flagship sockets, you are not going to continue to win the sockets.

And so the story of our device for at least for as long as I have been in Broadcom which is about seven years has continued on connectivity since the first day I got here just that the particular antagonist has changed overtime.

There is no question though that what is changing is on the low-end of the market. And so what you are seeing more of what’s happening at low-end and mid range of the market, less though on the high-end. And so can we have it in perpetuity and forever? I don’t know I think it’s really a product of innovation and strength and the quality of our engineering team which we feel quite good about. And we are going to continue to do that and I think we’ll continue to win.

Joe Moore - Morgan Stanley

And one of the things I think is encouraging on the connectivity side is that you do see the technology keep moving forward, you guys announced 2x2, MIMO, Wi-Fi and overall it looks like there is pretty good adoption already. If I get AC adoption from some of the high profile phones for 11 year ago, so I feel like technology does keep moving forward. Is there a sort of an ASP benefit you can talk about that when you talk about MIMO?

Eric Brandt

Yes. And so the opportunity for growth really relies a little bit on the growth of smartphones which people have sort of the mid single-digit range and certainly in the high-end smartphones, but really in our case, it’s a product cycle as we see the step from 1x1 AC to 2x2, MIMO and you will see the flagship on that that has that and then the further adoption of 2011 AC more broadly into a number of other products which have not yet adopted. And so that helps in terms of the ASP lift in the revenue side.

Obviously all of that contingent on what is the overall growth of smartphone market, what is the mix of that growth between the high-end and low-end. But to extent that there are exciting high-end products that come out this year I think will benefit from that.

Joe Moore - Morgan Stanley

Okay, great. So I guess looking at the baseband then, I mean last year you had a lot of pricing pressure in 3G. Can you talk about what caused that? Is that just sort of the latter stages of 3G market? It sounds like you’re even talking to -- mobile that there is even pricing pressure now on lowering LTE this year. Why is that such a price….

Chris Zegarelli

Look I think that there has been some aggressive price action that’s gone on principally in China and some of the people who sell into China sort of spillover. And so they are local competitors that are competing fiercely and aggressively and then there are friends on the South who are trying not to give up ground in that process. And I think what happens then is that it begins to spill over into other parts of the market and 3G has become pretty aggressive in terms of the pricing structure of 3G. And I think margins are becoming very tight in 3G. And people are going to have to optimize the chips.

On the LTE side, it does spillover a little bit I think on the low-end and there will be certainly a little bit more of a [food play] of competition on the low-end probably in the near-term. But the real challenge really in LTE is to find your way to the high-end and deliver the kinds of products that are Cat 6 and VoLTE and Carrier Aggregation and all of the other things that go along with some of those high-end products and produce things that people are willing to pay the technology for as oppose to swap in and out.

Joe Moore - Morgan Stanley

Okay. And with your own baseband technology on the LTE side, I mean a year ago when we talked you guys were fairly enthusiastic about the same technology and then you rerouted a little bit when the Renaissance’s assets became available. Can you talk about that and what that opportunity?

Chris Zegarelli

Yes. Again I think that’s a product of approach we take and not the similar from the conversation we had about the controller business on a portfolio view. Somebody asked me earlier today, are you bias towards doing things internally versus buying them? And initially the first view is almost always to do it internally and to the extent that you find an asset an opportunity which is better than what you think you have more ready more mature and helps you enter the market you have to do a very difficult economic analysis and it was a tough choice for the company. It was certainly a tough choice in terms of the business assets and the switch on the business assets and it’s a tough choice in terms of the impact of employees because we obviously have to make a bad on a different set of employees from the employees we had at the time.

But I think it goes to the -- what I hope is sort of reasonable level of discipline of a management team to say that there is something better out there than you can’t be waited for something you don’t believe will actually gets you to where you need to be as quickly as the new asset.

Joe Moore - Morgan Stanley

Okay, great. And can you give us an update on where those assets are taking you, obviously you have couple of sockets?

Chris Zegarelli

Yes. So the way to think about it right there is technical milestone, there is commercial milestones and ultimately they produce economics at the bottom. If you look at the technical milestones in terms of the tape out of the products, performance of the products et cetera, I would say we are hitting and as we talked about at our Analyst Day, we’re hitting all of those milestones in fact if anything slightly sooner.

On the commercial side, we said that we would shift in the first part of the year then we said we shift in Q1 and as we have we shift in Q1 and you could see that phone had Mobile World Congress. There are other products that are coming, I think that’s good. The engagement on the customer side is broadening, which is also good. And then all of that sort of leads to the most important part which is the underlying economics. And I think the challenge is always to make sure that as you deliver on the technical milestones and the commercial success you are driving a set of economic successes which make this a good and attractive business for the company and for our shareholders.

Joe Moore - Morgan Stanley

Okay, great. And you’ve talked about nine figures in revenue from that business this year, obviously the long-term aspirations got to be a lot bigger than that, the R&D investment there are -- when do you know if you can sort of has billions of dollars of revenue at some point, when you know this is...?

Eric Brandt

Well look, I think we have a pretty good picture of the products we’ve got and sort of the customer engagement on those products and sort of the timelines that those things will begin to turn into product. What I can tell is how many of them are actually good products and how broadly people will sort of apply to those because you can get into a high runner at Samsung and can sell a million units a month, being getting to a low runner Samsung will sell 50,000 units a month.

And so the challenge is to get into enough models and we did this on 3G, we actually have the right portfolio mix of that and we actually benefit from it. Over the course of the year as we tape-out, as we quad-core and then go to the thin modem, which will be Cat 6 leading edge modem and then ultimately into an SoC. I think you will where the engagement is going and particularly on the leading edge modem which will really drive the economics of the business.

And so I think 2014 is an important year. Will I put a specific date on things, no but I think [2014] is a very important year in terms of a set of milestones to deliver the business.

Joe Moore - Morgan Stanley

And is the ultimate success factored in winning a big flagship type of phone?

Eric Brandt

Look, I think it’s important I think it’s a very important part because it’s indicative of the quality of the technology and sends a message to a broader set of suppliers that you are a technology leader. This industry needs a strong number two, it needs someone who can actually provide leading edge technology and provide competition. And so everybody is racing to that point. We feel that we are in a good place in terms of where we are in terms of that, in terms of both the modem and in terms of our ability to drive to an SoC. But that is an important sort of what I will call milestone, is it a got to have tomorrow, it’s hard to say but I do think it’s very important.

Joe Moore - Morgan Stanley

Okay, great. And I guess because I talked to a lot of companies that are in your position that are sort of buying for that number two space Intel and (inaudible) I feel like the carriers and the handset manufacturers would so much like to have an alternative that everybody sort of feels that possibility there and yet I don’t know if that’s something that those guys will do just to keep Qualcomm honest on pricing and then will stay with Qualcomm and you talked about connectivity of the barriers have been higher than people thought, it seems like in basement they have them as well.

Eric Brandt

I would that have but I would say people are catching up more quickly now. I think the lead that existed in 3G was multi year, I think the lead that exists in LTE is probably one or two years. And there is no question that the carriers are specifically asking the OEMs for chipset diversity. And the challenge for the OEMs is to find someone who can provide that. I think you are right that there are lot of people chasing it and I think someone is going to find themselves dropped into that slot and that slot will generate the economics that enable you to fund the R&D that is important to expand this business. And to the extent that you don’t drop into that slot, it’s going to be very challenging to manage the economics.

Joe Moore - Morgan Stanley

Great. And I will just ask one question and then I will open it to the audience. In terms of the guidance that you gave that wireless would be down and when we talk about connectivity growing for the year, what’s the assumption in terms of bills because when we talk to the supply chain on some of the big phones that are launching in the first half, everybody is kind of building less than they did a year ago, which I think is good news because they booked too many this time last year, but at the same time they are building less because they are less optimistic about sale, what is your expectation?

Eric Brandt

Well, I would say look, we said in the call, we thought the second half would be much stronger than the first half and I think we still believe that and that relates to both product cycles and a variety of other things going on in terms of the nature of the ramp of the technology. But your point is very important, which is if it turns out that the market doesn’t grow, it could change that assumption. I think we do believe that the market will grow, as I said I think the current estimates are sort of mid to high single digits for the growth of smartphones. And to the extent that and there is an exciting new high end smartphone and I don’t know exactly what feature would drive it. But there hopefully is a feature that drives the consumer to trade in their phone or get a new phone. So that will drive the value and connectivity. And as we get further expansion of AC, MIMO etcetera, I think you are going to see the benefit of that, but the challenge right as you say on the supply chain is how excited are people on the high end of smartphones and there needs to be innovation.

Joe Moore - Morgan Stanley

Right. Unless if there is any question from the audience and I will keep going? On that front.

Unidentified Analyst

Historically, you guys have done really well on the connectivity sides by been able to integrate so many functions into a chip. Now that you guys are very close to having your own SoC Qualcomm has already come out to move beyond just the SoC and are up to the RF front and on CMOS and you guys are very, very strong in CMOS as well. Do you guys feel that you need to have an RF integrated CMOS product for further integration of the phone going forward?

Eric Brandt

Possibly. I wouldn’t say immediately, but I’d say possibly. At this point I think we’re focused on what we’re focused on. Do we have the technology to do, I think we have the technology to do. And do I think it’s possibly, yes. Is it something that we are racing to do first, I would say it is second it is not first.

Unidentified Analyst

Eric, you touched on smartphones and innovation. It just seems just based on the feedback from 3G (inaudible) and kind of where we are with Apple now basically exhausting the resources would be launching a larger screen phone what we’re in part to innovate more on that device. What is your suggestion in terms of meeting more innovation, what would you suggest or does it lead in another direction is it variables or is there another way for you guys with internet of thing et cetera?

Eric Brandt

Yes. So I be it far for me to advise our friends in Cupertino in terms of how to design a phone or design a product because I think they’re awesome at what they do and someone who has I don’t know 8 or 9 iPads in their house, I am a big customer.

But having said that I think that the consumer wants new things and they want to be excited about the device they’ve got and whether that’s a new screen or an ecosystem as you described in terms of [wearables] et cetera. I think those are the kinds of things that are going to drive things together. And as we know sort of if you buy products from Apple there is that ecosystem that you sort of get used to and the ease of operating within that ecosystem. I don’t know exactly what they have up their sleeve, in fact frequently we don’t even have an idea of what the product is that they’re designing that we’re in. But my hope is that they do deliver on what they’ve been talking about; they do get the consumer excited; that they do get people globally interested in buying more products and that we are in those products that they sell. But at some point, you do need a level of innovation to get people excited about buying things and changing and trading up et cetera, because they are not cheap, right? I mean if you think about it, you are buying a smartphone now, unsubsidized is probably $1,000 device, I mean that’s a really nice PC and this is a smartphone.

So I don’t have specific advice for them, I think that they are very capable people, far more capable than I am. And I’m sort of just a little part inside.

Unidentified Analyst

As LTE ramps as the year progresses, do you think that you will be able to benefit from a mix shift perspective to help offset, on the gross margin line to help offset the price pressure that you talk about on 3G?

Eric Brandt

Well look, I think that the price points on LTE will be higher than price points on 3G. And the question will be sort of what the mix of products are and are you actually -- at a point we’re actually generating increased margin and increased functionality. Is there an opportunity to do that? Yes, I think there is an opportunity to do that. And I think one of the exciting things about the asset we bought is they do bring one of the smallest dies in the space for LTE. The challenge for us is that it’s not in our product flow and it’s not optimized to our product flow yet, so we do get some gross margin, get associated with that. But I do think that if the market does begin to separate in terms of technology and who provides that, like we saw in Wi-Fi that years ago when the margins weren’t very good and now they are very good, I think you can see the same thing happen in baseband.

Unidentified Analyst

Yes. Question over here, do you see any value in...

Eric Brandt

Where is the question?

Unidentified Analyst

Right over here. Do you see any value in potentially spinning off any one of the businesses?

Eric Brandt

Value in selling off any of the businesses?

Unidentified Analyst

In spinning off any one of the businesses?

Eric Brandt

Spinning off is a challenging question. I don’t know whether spinning off creates value or doesn’t create value. You’d have to take a hard look at that. And I don’t know which business you are talking about per se, you probably have something in mind I assume. You are talking about mobile?

Unidentified Analyst

No. Whether it would be broadband, whether it would be in terms of what seems to be a pretty undervalued stock, potential ways to realize that value, would you consider doing something like that?

Eric Brandt

Yes, and I would say look we understand that and I think that’s why I said I think it’s an important year to prove that we can deliver on the mobile strategy. In terms of spinning out broadband or infrastructure or those sorts of things, it’s hard to say that they create a whole lot of value. I don’t really know. I do think that there is lot of shared technology and a lot of the secret sauce exists in central engineering. I mean a lot of that sort of is partition between wired and wireless and there is analog that everybody uses. But I don’t know, we are not -- certainly not opposed to something that creates value for our shareholders.

Joe Moore - Morgan Stanley

And the push we get on the some of the parts is that mobile and wireless will -- could lose money I mean and you are trending -- operating margins are trending low single digits now.

Eric Brandt

And Joe I absolutely understand that; we all understand that as a management team. I think in a period of time where an industry is growing at double digits and smartphones are growing at 35%, there was a level of economic flow into the company that allowed us to do certain things that is more challenging to do today. And we all understand that. And so as a result, I think this is why you have a level of spotlight and focus on the business inside the company that is as bright as it’s ever been. And I think it’s true for every company. And probably one of the reasons why everybody talks about consolidation in the industry because the -- an industry that’s going to grow sort of mid single digits with a cost structure that’s growing as you sort of move down the process know your ability to be efficient and drive value and make the right portfolio choices is critical for a business.

Joe Moore - Morgan Stanley

We have time for one more.

Eric Brandt

Yes.

Unidentified Analyst

Eric, as a CFO of the company, I am sure you heard some feedback about concern that the market has, not just about this underperformance that has occurred in the business and the stock’s underperformance alongside, but also the share issuance. I mean there is a feeling that the senior management team is not sharing [the thing] that shareholders have held in Broadcom stock. Recently, there was an increase in issuance as opposed to a decline. Can you sort of help us understand how seriously does management takes those sort of concerns and how do you think about the free cash flow conversion a little as it is because the OP margins have fallen in the leakage that occurs to employee expenses?

Eric Brandt

Sure. Look, we take it extraordinarily seriously. Look, I take it seriously; I spend my time talking about it with my peers, with our board et cetera. As a company, we have seen our stock issuance go from 14% of revenue to go down to the sub 6% level and I think it’s going to continue to go down to the 5% range. And so as a company, we are moving very aggressively to reduce our stock-based compensation.

In terms of how we feel about the stock price and the issuance of equity, we are very focused on it. I think we’ve probably designed a compensation system more towards the momentum based industry and probably not as much around sort of capital return and TSR. And we will add TSR this year to our performance metrics and the way we measure ourselves as a management team.

Joe Moore - Morgan Stanley

And with that we are out of time. Thank you very much, Eric.

Eric Brandt

Thank you.

Joe Moore - Morgan Stanley

Yes.

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