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Broadcom (AVGO -0.84%)
Q3 2024 Earnings Call
Sep 05, 2024, 5:00 p.m. ET
Contents:
Prepared Remarks
Questions and Answers
Call Participants
Prepared Remarks:
Operator
Welcome to Broadcom Inc.’s third quarter fiscal year 2024 financial results conference call. I would now like to introduce Ji Yoo, head of investor relations of Broadcom, Inc.
Ji Yoo — Director, Investor Relations
Thank you, operator, and good afternoon, everyone. I am joined today by Hock Tan, our president and CEO; Kirsten Spears, our chief financial officer; and Charlie Kawwas, president of the Semiconductor Solutions Group. After the market closed, we distributed a press release along with financial tables detailing our performance for the third quarter of fiscal year 2024. If you need a copy, it is available in the Investors section of our website at broadcom.com.
This call is being webcast live, and an audio replay will be available for one year on our website. During our prepared remarks, Hock and Kirsten will discuss our Q3 fiscal year 2024 results, provide guidance for Q4, and share insights on the current business climate. We will address questions after our presentations. For details regarding risk factors that could influence our results, please refer to our press release and SEC filings.
Broadcom reports certain financial metrics outside of U.S. GAAP standards. A reconciliation of GAAP and non-GAAP metrics can be found in the tables accompanying today’s press release. Key comments during this call will focus primarily on our non-GAAP financial results.
I will now hand the call over to Hock.
Hock E. Tan — President, Chief Executive Officer, and Director
Thank you, Ji, and thank you all for joining us today. For our fiscal Q3 2024, we reported consolidated net revenues of $13.1 billion, an impressive increase of 47% compared to last year, with operating profit rising 44% year on year. These results can be attributed to three main factors: robust growth in AI revenues, accelerated bookings from VMware, and stabilization in our non-AI semiconductor revenue.
Moving forward, I will provide guidance specifically for Q4 rather than an annual outlook, as we are now in the final quarter of 2024. In our software segment, Q3 revenue reached $5.8 billion, marking a 200% year-on-year increase, bolstered by $3.8 billion from VMware.
The integration of VMware is progressing effectively. Recently, we held our first combined VMware Explore Conference in Las Vegas, which emphasized the VMware Cloud Foundation (VCF). This full software stack modernizes data center operations and facilitates private cloud environments for enterprises. Our success is underscored by securing over 15 million CPU core bookings for VCF this quarter, translating into an annualized booking value of $2.5 billion, reflecting a 32% increase from Q2. Furthermore, we have successfully reduced VMware spending from $1.6 million in Q2 to $1.3 million in Q3, showcasing the efficiency improvements we are driving.
We aim to reach an adjusted EBITDA of $8.5 billion within three years post-acquisition of VMware, and we are on track to meet or exceed this target by fiscal 2025. Now, looking at our semiconductor segment, Q3 revenue in networking was $4 billion, representing a 43% year-on-year increase and accounting for 55% of semiconductor revenue. The surge is largely driven by heightened demand from hyperscalers for AI networking and custom AI accelerators, with custom AI sales expanding three and a half times compared to the previous year.
In Ethernet switching, particularly driven by Tomahawk 5 and Jericho3-AI, we experienced over a fourfold year-on-year growth. Optical lasers and thin dies used in optical interconnects also tripled in sales, while PCI Express switches demonstrated a twofold increase. Our industry-leading five-nanometer 400-gigabit-per-second NICs and 800-gigabit-per-second DSPs are now shipping in substantial volumes.
In terms of non-AI networking products, we observed a 17% sequential uptick in Q3, despite a 41% drop when compared to last year. We anticipate this trend will stabilize, with year-over-year declines moderating to approximately 30%. Overall, we project total networking revenue will grow over 40% year on year in Q4, driven by AI demand.
Turning to the broadband segment, Q3 sales contracted by 49% year on year to $557 million due to a slowdown in telco and service provider investments. We foresee continued weakness in broadband into Q4 but predict a recovery in 2025. In summary, we have reached the bottom in our non-AI markets and are poised for a rebound in Q4, while AI revenue is expected to rise 10% sequentially to exceed $3.5 billion, culminating in $12 billion for fiscal 2024—up from our previous estimate of over $11 billion.
For Q4, we estimate semiconductor revenue will approximate $8 billion (up 9% year on year) and infrastructure software revenue around $6 billion. Hence, our consolidated revenue forecast for Q4 stands at approximately $14 billion, reflecting a 51% year-on-year increase. We anticipate this will drive our Q4 consolidated adjusted EBITDA to approximately 64% of revenue.
This guidance translates to an uplift in our fiscal 2024 revenue outlook to $51.5 billion, with adjusted EBITDA expected to reach 61.5%. Now, I will pass the call over to Kirsten.
Kirsten M. Spears — Chief Financial Officer and Chief Accounting Officer
Thank you, Hock. I will now detail our Q3 financial performance. We reported consolidated revenues of $13.1 billion for the quarter, marking a 47% increase from last year. Excluding VMware’s contributions, revenue rose by 4% year on year.
Our gross margins were 77.4% for the quarter. Research and development expenses amounted to $1.5 billion, with consolidated operating expenses reaching $2.2 billion, primarily due to VMware consolidation. Q3 operating income was $7.9 billion, an increase of 44% year on year, resulting in an operating margin of 61% of revenue. Adjusted EBITDA stood at $8.2 billion or 63% of revenue, excluding $149 million in depreciation.
Focusing on our segments, our semiconductor solutions segment generated $7.3 billion, constituting 56% of total revenue, up 5% year on year. Gross margins for this segment were about 68%, down 270 basis points year on year, mainly due to a higher proportion of custom AI accelerators. Operating expenses increased by 11% year on year to $881 million, driven by increased R&D investment, leading to semiconductor operating margins of 56%.
In contrast, infrastructure software revenue was $5.8 billion, largely attributed to VMware, representing 44% of total revenue and reflecting a 200% year-on-year increase. The gross margins for infrastructure software reached 90%, with operating expenses of $1.3 billion, resulting in a segment operating margin of 67%.
Looking at cash flow, our free cash flow for the quarter was $4.8 billion, representing 37% of revenue. After adjusting for $529 million used in restructuring and integration, free cash flow rose to $5.3 billion, up 14% year on year, representing 41% of revenue. This percentage declined relative to last year due to increased interest expenses and higher U.S. cash taxes, compounded by delays related to the reenactment of Section 174.
We invested $172 million in capital expenditures this quarter and maintained a disciplined inventory approach, ending Q3 with $1.9 billion in inventory, a 3% increase from Q2. Our cash balance at the end of Q3 stood at $10 billion, accompanied by $72.3 billion in gross principal debt.
Notably, we refinanced $5 billion in floating rate notes with fixed-rate senior notes and reduced floating rate debt by an additional $4.2 billion using proceeds from the sale of VMware’s end-user computing business and cash reserves. The weighted average coupon rate on our fixed-rate debt stands at 3.6%, with a maturity of 7.7 years, while floating rate debt averages 6.7% over 3.1 years. We plan to repay approximately $1.9 billion in fixed-rate senior notes due in Q4.
In terms of capital allocation, we returned $2.5 billion to shareholders in cash dividends, translating to a dividend of $0.525 per share. For Q4, we will increase the dividend to $0.53 per share. The split-adjusted non-GAAP diluted share count for Q3 was 4.92 billion. We paid $1.4 billion in withholding taxes upon equity vesting, eliminating 8.4 million AVGO shares, with an anticipated diluted share count of about 4.91 billion in Q4.
Guidance for Q4 includes a consolidated revenue target of $14 billion and adjusted EBITDA of about 64%. We expect sequential gross margins to decline by approximately 100 basis points due to a higher semiconductor revenue mix. GAAP net income and cash flows in Q4 will be affected by elevated tax obligations, and costs associated with restructuring and integration tied to the VMware acquisition.
Now, I will open the floor for questions.
Questions & Answers:
Operator
Thank you. [Operator instructions] Please limit your questions to one due to time constraints. We will now compile the Q&A roster. The first question will come from Vivek Arya with Bank of America.
Your line is open.
Vivek Arya — Analyst
Thank you for taking my question. For clarification, Hock, AI revenue was around $3.1 billion in Q3, staying flat sequentially. What was the breakdown between compute and networking? Additionally, how do you forecast the mix for the projected $3.5 billion in Q4? Lastly, while you’re not providing overall guidance for fiscal ’25, how confident are you that Broadcom can grow at or above the industry rate in AI silicon?
Kirsten M. Spears — Chief Financial Officer and Chief Accounting Officer
In Q3, our AI revenue comprised approximately two-thirds from compute and one-third from networking, and we expect a similar distribution in Q4. As for fiscal ’25, we do anticipate strong growth in AI revenue.
Vivek Arya — Analyst
Thank you.
Operator
Thank you. One moment for the next question from William Stein with Truist Securities. Your line is open.
William Stein — Analyst
Thanks for taking my question. Hock, we’ve noticed a shift in revenue from cloud service providers to enterprises within the AI ecosystem. How do you view this trend, considering your focus on hyperscalers?
Hock E. Tan — President, Chief Executive Officer, and Director
That’s an intriguing question, but our focus remains on the large hyperscaler customers. We are less involved in the enterprise AI market.
Operator
Thank you. One moment for the next question from Ross Seymore with Deutsche Bank. Your line is open.
Ross Seymore — Analyst
Thank you for the time. Hock, regarding the strong performance from VMware, was there a drop in the classic Broadcom software segment? If so, what’s the trajectory for that segment as we head into Q4?
Hock E. Tan — President, Chief Executive Officer, and Director
Yes, while VMware bookings remain high, we are seeing variability in the classic Broadcom software segment, primarily due to changes in customer engagement, particularly with Brocade. However, we are optimistic about VMware’s continued strength.
Operator
Thank you. One moment for the next question from Stacy Rasgon with Bernstein Research. Your line is open.
Stacy Rasgon — Analyst
Thank you. For semiconductors, non-AI networking remains significantly below its previous levels. Is this decline cyclical or indicative of underlying issues? How should we view the stability of non-VMware software revenue moving forward?
Hock E. Tan — President, Chief Executive Officer, and Director
This downturn has largely been cyclical as our customers have been adjusting inventory levels. We believe we’ve seen the bottom in our non-AI markets, and with solid bookings in Q3, we anticipate a continued recovery.
Operator
Thank you. One moment for the next question from Ben Reitzes with Melius Research. Your line is open.
Ben Reitzes — Melius Research — Analyst
Thanks. Hock, regarding your AI revenue, was the $3.1 billion in line with expectations, and where do you foresee the growth coming from in Q4? Also, what factors lead you to anticipate notable AI revenue growth next year?
Hock E. Tan — President, Chief Executive Officer, and Director
The third quarter revenue was in line with our projections, and our forecast for Q4 aligns with the existing backlog of AI accelerators and networking. We believe our strong relationships with hyperscalers will lead to significant growth next year.
Operator
Thank you. One moment for the next question from Karl Ackerman with BNP Paribas. Your line is open.
Karl Ackerman — Analyst
Thanks. Kirsten, regarding the relocation of IP back to the U.S. and the associated $4.5 billion tax liability, could you clarify the rationale behind this move and its potential implications for asset sales?
Kirsten M. Spears — Chief Financial Officer and Chief Accounting Officer
This decision was based on timing and is not tied to asset sales. This relocation resulted in a non-cash deferred tax liability.
Operator
Thank you. One moment for the next question from Timothy Arcuri with UBS. Your line is open.
Timothy Arcuri — Analyst
Thank you. Hock, regarding your AI revenue growth relative to the GPU segment, do you believe the growth trajectories will diverge next year based on customer behavior in the custom silicon market?
Hock E. Tan — President, Chief Executive Officer, and Director
The dynamics of AI growth and GPU demand must be assessed separately. While we are focused on enabling hyperscalers, the shift to custom silicon aligns with the growing need for optimized performance and we expect this to continue.
Operator
Thank you. One moment for the next question from Harsh Kumar with Piper Sandler. Your line is open.
Harsh Kumar — Analyst
Hi Hock, regarding VMware, its historical operating margin exceeds 70%. Do you see a similar margin profile post-integration as costs are streamlined?
Hock E. Tan — President, Chief Executive Officer, and Director
Given the trajectory of revenue growth paired with our efforts to streamline expenses, projections for margin improvement at VMware appear favorable.
Operator
Thank you. One moment for the next question from C.J. Muse with Cantor Fitzgerald. Your line is open.
C.J. Muse — Analyst
Thank you. Hock, concerning gross margins in your software segment post-VMware acquisition, what should we anticipate moving forward?
Hock E. Tan — President, Chief Executive Officer, and Director
The gross margin for our software segment remains robust, with expectations around 90% as we transition to higher-margin subscriptions and streamline operations.
Operator
Thank you. One moment for the next question from Chris Caso with Wolfe Research. Your line is open.
Chris Caso — Analyst
Can you discuss the impact and significance of gaining new AI customers beyond your current hyperscaler clients? We are eager to understand the outlook as these projects ramp up.
Hock E. Tan — President, Chief Executive Officer, and Director
We are witnessing engagement from three significant customers in AI accelerators, and we expect production volumes to grow as their deployments scale.
Operator
Thank you. One moment for the next question from Christopher Rolland with Susquehanna. Your line is open.
Christopher Rolland — Analyst
Hock, could you elaborate on your recent acquisition of Seagate’s hard disk drive SoC assets and what this means for Broadcom’s storage business?
Hock E. Tan — President, Chief Executive Officer, and Director
This acquisition focuses more on collaboration rather than ownership of products. We are committed to enhancing hard disk storage capabilities while continuing to innovate alongside Seagate, with expectations to reach significant storage capacities in the coming years.
Operator
Thank you. One moment for the next question from Aaron Rakers with Wells Fargo. Your line is open.
Aaron Rakers — Analyst
Regarding NVIDIA’s upcoming Blackwell product cycle, do you see opportunities for Broadcom to engage more deeply in the optical segment associated with this product?
Hock E. Tan — President, Chief Executive Officer, and Director
We are positioned to contribute components that could support NVIDIA’s roadmap, particularly in offering necessary interconnects for their systems.
Operator
Thank you. One moment for the next question from Joe Moore with Morgan Stanley. Your line is open.
Joe Moore — Analyst
Hock, could you share any insights on potential mergers and acquisitions moving forward? Will they continue to focus primarily on software, or are there semiconductor opportunities on the horizon?
Hock E. Tan — President, Chief Executive Officer, and Director
Right now, our focus remains on optimizing the integration of VMware, and I am not actively pursuing M&A opportunities at this time.
Operator
Thank you. One moment for the next question from Harlan Sur with JPMorgan. Your line is open.
Harlan Sur — Analyst
Hock, as you note increased R&D investments from your AI customers, are you witnessing a corresponding uptick in orders for XPUs and networking capabilities, and can your team handle this increased demand?
Hock E. Tan — President, Chief Executive Officer, and Director
Yes, we are experiencing an upswing in orders and have been able to meet this increased demand without constraints. We anticipate this trend continuing as AI infrastructure deployment accelerates.
Operator
Thank you. One moment for the final question from Edward Snyder with Charter Equity Research. Your line is open.
Edward F. Snyder — Analyst
Hock, you previously suggested a transition from GPUs to custom silicon might reshape as AI accelerators gain prominence. Is this still an expected trajectory, and how will this impact future demand?
Hock E. Tan — President, Chief Executive Officer, and Director
Indeed, we believe the demand for custom silicon will rise as hyperscalers seek to optimize their performance needs. The transition may take time, but the momentum is building towards that outcome.
Operator
That concludes the question-and-answer session. I would now like to turn the call back over to Ji Yoo for any closing remarks.
Ji Yoo — Director, Investor Relations
Thank you for joining us today. Broadcom will be presenting at the Goldman Sachs Communacopia and Technology Conference on September 11 in San Francisco. We will report our earnings for the fourth quarter and fiscal year 2024 after market close on December 12, 2024, with a public webcast to follow at 2 p.m. Pacific time.
That concludes our earnings call today. Thank you for participating. Operator, you may end the call.
Operator
[Operator signoff]
Duration: 0 minutes
Call participants:
Ji Yoo — Director, Investor Relations
Hock E. Tan — President, Chief Executive Officer, and Director
Kirsten M. Spears — Chief Financial Officer and Chief Accounting Officer
Vivek Arya — Analyst
William Stein — Analyst
Ross Seymore — Analyst
Stacy Rasgon — Analyst
Ben Reitzes — Melius Research — Analyst
Karl Ackerman — Analyst
Timothy Arcuri — Analyst
Harsh Kumar — Analyst
C.J. Muse — Analyst
Chris Caso — Analyst
Christopher Rolland — Analyst
Aaron Rakers — Analyst
Joe Moore — Analyst
Harlan Sur — Analyst
Edward F. Snyder — Analyst
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