As a shareholder, I’m rather excited about the jump in SWKS stock price that came as a result of the earnings report I’m about to analyze. That said, I’m a bit worried that the price run-up is a little overdone in the near-term. Longer-term, there was a fair amount of positive commentary during the analysts’ conference call accompanying the earnings report. Without further ado, let’s dig in.
Earnings Report Highlights
The earnings press release can be found here: http://investors.skyworksinc.com/releasedetail.cfm?ReleaseID…. Seeking Alpha’s transcript of the conference call can be found here: http://seekingalpha.com/article/4038135-skyworks-solutions-s…. (Thanks, Seeking Alpha.) Unless stated otherwise, all italicized quotations are from the Seeking Alpha transcript.
1Q17 Revenue: $914.3 million Revenue declined 1.3% from 1Q16, but was up 9% sequentially. Things have improved at Apple (they’re back to being a 40% customer), but some of this quarter’s results reflect the widely-publicized problems at Samsung. Samsung had been Skyworks’ second-largest customer, but they’ve dropped to third, with Huawei taking over the second spot. Skyworks did report that they are seeing improvement in Q2 and beyond from Samsung. Wall Street expected $902.7 million and guidance was $893.9-910.6 million, so the slowdown from Samsung was clearly expected.
In millions. Note: These quarters are based on Skyworks’ fiscal year, which ends around Sept. 30. 1Q 2Q 3Q 4Q Comments 2012 393.7 364.7 389.0 421.1 2013 453.7 425.2 436.1 477.0 Y-o-Y 15.2% 16.6% 12.1% 13.3% 2014 505.2 481.0 587.1 718.2 3Q14 Panasonic JV Y-o-Y 11.4% 13.1% 34.6% 50.6% 2015 805.5 762.1 810.0 880.8 Y-o-Y 59.4% 58.4% 38.0% 22.6% 2016 926.8 775.1 751.7 835.4 2-4Q16 Apple slowdown Y-o-Y 15.1% 1.7% -7.2% -5.2% 2017 914.3 Y-o-Y -1.3%
1Q17 Gross Margin: 50.7% GAAP and 51.2% non-GAAP Management guided to 51% non-GAAP gross margins. They continue to target 53% non-GAAP gross margins as a reasonable mid-term goal, and still expect to exit 2017 at 52% non-GAAP gross margins.
1Q17 Operating Margin: 35.2% GAAP and 38.8% non-GAAP Operating margin improved from last quarter (34.9% GAAP and 38.1% non-GAAP), but declined from last year’s first quarter (35.7% GAAP and 39.6% non-GAAP). I think this is largely a reflection of 1Q17 revenue being larger than 4Q16 revenue, but below 1Q16 revenue. Management continues to see 40% non-GAAP operating margin as an attainable mid-term goal.
1Q17 Net Income: $257.8 million ($1.38 per diluted share; $1.61 non-GAAP) This is an improvement from last quarter’s $246.8 million ($1.31 per diluted share; $1.47 non-GAAP). Officially, 1Q16 net income was $355.3 million ($1.82 per diluted share; $1.60 non-GAAP). Before you reel backwards and gasp in horror at the decline from 1Q16 to 1Q17, please remember that 1Q16’s GAAP results included the PMC-Sierra merger termination fee. Removing that, one still sees a decline in results from $266.8 million ($1.37 per diluted share), but it is much better aligned with the 1.3% decline in revenues. The non-GAAP amount is unchanged. You can see the effects of the share buy-backs in the comparison between 1Q16 and 1Q17 – despite lower net income in 1Q17, earnings per share were higher. The share count is actually down to levels not seen since 2010. Management had guided towards $1.58 in non-GAAP earnings per share, and Wall Street expected that same amount.
Earnings per Share (GAAP) 1Q 2Q 3Q 4Q Comments 2012 0.30 0.18 0.26 0.32 2013 0.34 0.32 0.34 0.44 2014 0.49 0.40 0.58 0.90 2015 1.01 0.85 1.06 1.18 2016 1.82 1.08 0.97 1.31 1Q16 incl PMCS fee ~$0.45 2017 1.38 Earnings per Share (non-GAAP) 1Q 2Q 3Q 4Q Comments 2012 0.51 0.42 0.45 0.53 2013 0.55 0.48 0.54 0.64 2014 0.67 0.62 0.83 1.12 2015 1.26 1.15 1.34 1.52 2016 1.60 1.25 1.24 1.47 2017 1.61
1Q17 Cash Flow From Operations (CFFO): $495.9 million; Capital Expenditures (CapEx): $50.1 million; Free Cash Flow (FCF): $445.8 million Last quarter, I was quite effusive about the cash flow results, calling them “stunningly good”, noting that the “CFFO number exceeds the prior record by almost 19%, and it exceeds the average CFFO amount over the last three years by almost 91%”, and further elaborating that the incoming Chief Financial Officer (CFO) “… sure knows how to win friends!”. Well, this quarter’s CFFO results were about 9% better than last quarter’s. CFO Kris Sennesael continued to magically transform the working capital numbers, trimming eight more days off both “days sales outstanding” and “days of inventory”. Unfortunately, CFO Sennesael indicated, “… you won’t see a repeat of those … improvements in working capital”, although he predicts Skyworks “… will continue to generate a ton of cash every quarter going forward.” This quarter’s CapEx is better aligned with current depreciation rates than last quarter, where I described the level of spending as “unrealistically low”.
2Q17 Guidance Management expects Q2 revenue of $840 million. Non-GAAP earnings are expected to be $1.40 per share. Non-GAAP gross margin is expected to be in the low 50% range. Wall Street’s estimates of 2Q17 revenue and non-GAAP earnings were $818 million and $1.39, respectively. The decline in revenue and earnings from this quarter is not a concern – Q2 results are Skyworks’ weakest, seasonally. Last quarter I noted that a 6% decline from Q1 to Q2 is typical, so I’m not worried about this 8% decline, although I had hoped for better.
Cash, Cash Equivalents, and Investments: $1.35 billion The company is currently debt free. Cash balances increased by more than a quarter of a billion dollars, despite almost $160 million being returned to shareholders – roughly two-thirds of that as share buy backs and one-third in the form of dividends. A new $500 million share repurchase program was announced in conjunction with earnings.
SWKS earnings day share price: $88.67 +13.01% (vs. S&P 500 +0.34%) I’ll take these results! Skyworks just jumped from #16 in my portfolio to #11. If I were better coordinated (and knew no one was looking), I’d consider attempting a “happy dance”. Then again, the current share price implies a multiple of roughly 18.7 applied to trailing twelve month GAAP earnings. That seems a bit high to me, unless the market is expecting better than mid-teens growth going forward.
1000 Days of Ratios Analysis
The analysis is based 1000 trading days, ending January 20, 2017 with a closing price of $88.67. TTM stands for “Trailing Twelve Months”. I use GAAP earnings, but I’ve excluded the effects of the PMC-Sierra merger termination fee from my database.
Current Price to Earnings Ratio: 18.69x (best 40% – range is 12.38x to 35.23x)
Current Price to Sales Ratio: 5.12x (worst 26% – range is 2.34x to 7.59x)
Current Price to Free Cash Flow Ratio: 15.33x (best 8% – range is 12.69x to 34.84x)
25% P/E cut-off ratio is 17.13x. TTM earnings per share are $4.74. P/E-based target is $81.26.
25% P/Sales cut-off ratio is 3.11x. TTM sales per share are $17.30. P/Sales-based target is $53.81.
25% P/FCF cut-off ratio is 17.31x. TTM FCF per share is $5.78. P/FCF-based target is $100.11.
Suggested Attractive Price: $78.39
I remain of the opinion that this analysis is currently flawed due to the transformative nature of the Panasonic joint venture. This point is driven home to me by the widely disparate targets that each of the ratios suggest. At this point, less than half the data base is from before the joint venture, so the data base is improving with time. When I sort the data by each of the financial ratios, the cheap ratios are consistently found in the oldest data. The current “suggested attractive price” has increased largely due to this quarter’s effect on TTM FCF. The “suggested attractive price” based on 4Q16 results was $68.66; the market consistently traded above that price after 4Q16 earnings were released. This time the “suggested attractive price” is getting closer to reality, but that could be coincidence – as I said, please note the wide variation in the components that make up the average.
Product Mix Across Market Verticals
For the second quarter in a row, this data was offered reluctantly and only as an estimate (i.e., everything is rounded to the nearest 5%). Thanks to Vivek Arya of Bank of America/Merrill Lynch for being the first to ask, and to Timothy Arcuri of Cowen & Co. (a former employer of mine) for persisting and getting the question answered.
Power Amplifiers ¶ – This set of products has the lowest gross margins (40-45%) and slowest long-term growth (~5%). I’m happy to see these numbers shrink, or at least grow more slowly than the company as a whole.
Market Vertical Revenue in millions, with percent of company revenues in parentheses 1Q 2Q 3Q 4Q Comments 2014 $258.6 (36%) 2015 $249.7 (31%) $236.3 (31%) $194.4 (24%) $176.2 (20%) 2016 $148.3 (16%) $131.8 (17%) $120.3 (16%) $125.3 (15%) 2017 $137.1 (15%) Year-over-Year Growth 1Q 2Q 3Q 4Q 2015 -32% 2016 -41% -44% -38% -29% 2017 -7%
Integrated Mobile Systems (IMS) – These smartphone-enabling products have better gross margins (~50%) and better long-term growth prospects (15-20%).
1Q 2Q 3Q 4Q Comments 2014 $280.1 (39%) 2015 $386.6 (48%) $358.2 (47%) $429.3 (53%) $519.7 (59%) 2016 $593.2 (64%) $449.6 (58%) $413.4 (55%) $501.2 (60%) 2017 $548.6 (60%) Year-over-Year Growth 1Q 2Q 3Q 4Q 2015 86% 2016 53% 26% -4% -4% 2017 -7%
Broad Markets – A catch-all category for the set of products that support set-top boxes and media gateways, fitness bands, smart-watches and other wearable technologies, automotive technologies, connected home technologies, and products that support the Internet of Things (IoT). Gross margins are expected to exceed 50% in this market vertical, and the long-term growth rate should exceed 20%.
1Q 2Q 3Q 4Q Comments 2014 $179.6 (25%) 2015 $169.2 (21%) $167.7 (22%) $186.3 (23%) $193.8 (22%) 2016 $185.4 (20%) $193.8 (25%) $218.0 (29%) $208.9 (25%) 2017 $228.6 (25%) Year-over-Year Growth 1Q 2Q 3Q 4Q 2015 8% 2016 10% 16% 17% 8% 2017 23%
I’m pleased to see the return of increasing growth rates for Broad Markets.
Returning Money to Shareholders
I had been concerned that Skyworks was backing away from targeting a percentage of free cash flow to be returned to shareholders. This quarter, management restated such a target, or at least a target range: 40-50% of free cash flow. Skyworks didn’t quite achieve that this quarter (about 36%), but I’m quite OK with that. I do have a personal admission, though, regarding this policy. I grew to like it when SWKS stock price was pretty steadily increasing, so “yesterday’s” share repurchase always looked like it was done at attractive prices. Last year introduced a bit more volatility into the share price, and I increasingly recognize that targeting a percentage of free cash flow for return to shareholders can encourage share repurchases at suboptimal prices. I may wind up reconsidering my allegiance to this policy.
Other Random Musings
Bulk Acoustic Wave Filters
This topic received a lot of attention in the Q&A, and I think some of the commentary led to investor misunderstanding regarding Skyworks’ BAW manufacturing capabilities. Given that (1) prior management had set expectations for in-house BAW manufacture in 2017; and (2) Chief Executive Officer (CEO) Liam Griffin saying, “We do have BAW…”, such misinterpretations are easy to understand. However, it was clear to me from the context of the entire call that CEO Griffin was asserting that Skyworks does have access to BAW, which it buys from foundry partners. Skyworks is NOT manufacturing BAW filters itself. As a reminder, Skyworks’ filter expertise is in TC-SAW filters, which work very well in low and middle bandwidths, and are a low-cost, high-performance option. Skyworks has improved TC-SAW technology such that it is able to process higher bandwidths than it used to, but the highest bandwidths require more expensive BAW filters (or FBAR filters, which are a subtype of BAW filters). Competitors Qorvo and Broadcom are known for their capabilities in BAW and FBAR, respectively. For the past two earnings conference calls, CEO Griffin’s message has been consistent: Skyworks doesn’t need to manufacture BAW in-house. He points to differences between how 4G operates and how 5G (presumably) will operate. Specifically, he cites the differences between time-division duplexing and frequency-division duplexing (which sounds good but leaves me perplexing). That shift in dynamics seems to make BAW less necessary for addressing high frequencies.
In the near-term, CEO Griffin noted “a strategic design win at [the] leading U.S. electric car OEM.” I don’t think it is too much of a stretch to assume he means Tesla.
Further out, CEO Griffin notes that the amount of data expected to be consumed by a single autonomous car in 2020 is roughly the same as by 2,000 smartphone users today, and he believes that Skyworks is “… uniquely positioned to capitalize with solutions that solve all of these daunting connectivity challenges, setting the stage for outperformance across cars and new markets.”
Bullish Commentary (Or, Are Our Growth Expectations Too Low?)
There were certainly a handful of bullish nuggets that may have helped to drive Friday’s rally in the SWKS stock price.
First, from CFO Sennesael (although the Seeking Alpha transcript attributes this quote to the CEO): “… we’re very well positioned for further margin expansion in the second half of 2017 as we expect the next three quarters to see sequential revenue growth going forward.” CEO Griffin added, “… the second half fiscal and second half calendar year, you’re going to see revenue and margin step up.” This sounds great, but we’re starting at somewhat depressed levels due to Apple’s inventory issues. If this were the only juicy set of quotes, I wouldn’t have included this section.
Next, from CEO Griffin: “… as we look at March, we feel very good about our guidance … Backlog coverage is solid. We’re fully booked and it’s a very balanced quarter as well.” I especially like the comment about “balanced” because it suggests to me a larger than normal proportion of broad markets and Internet of Things (IoT) sales, which often carry higher margins. Additionally, increased sales into the Broad Markets segment tends to reduce Skyworks’ dependence on a few large smartphone manufacturers.
Back to CFO Sennesael: “we continue to in source some of the filter fabrication [in Japan] as well. And we haven’t really quantified that, but it’s going to have a meaningful impact on our further gross margin improvement in the second half of 2017.” I think the CFO’s point here may be a little obscure, so let me try to explain. I’ve repeatedly described buying Panasonic’s filter division as a transformative event for Skyworks. In prior earnings conference calls, management has talked about increasing that division’s capacity (basically, tripling it) and they’ve also indicated that each and every filter they’re manufacturing there is consumed within Skyworks products. What I think we’re being told is that, until the former Panasonic division is fully expanded, Skyworks has needed to buy additional filters from external sellers, which hurts margins. As we get into the second half of 2017, additional capacity will be in operation, so a much larger percentage of Skyworks’ filter needs will be produced internally, benefitting margins.
Finally, the last comment comes from CEO Griffin: “I think we weathered a bit of storm here in '16 and most of the clouds there have abated and it’s not just market shares. We’re gaining share, we’re creating new content. We’re expanding in IOT and in broad markets and [it’s] meaningful and [it’s] sustainable. We’re confident that the second half for us should be a double-digit growth rate year-over-year. We think we’ll have strength going into the next fiscal year as well just given our outlook and our design wins that we’ve secured recently. So, we feel good about it. Again, there is room to go on the margin line. We’re going to work that. The demand side let’s say, looks very good and more diversified I should add.” A return to sustained double-digit growth would be most welcome after a difficult 2016. Being able to simultaneously expand margins will magnify the effects of that growth on the bottom line. Having the business be more “diversified” is beneficial for the reasons stated a couple of paragraphs ago.
That said… Growth in the 10-12% range counts as double-digit growth. With the PE ratio currently well above 18x, I’m not sure that any of us would be satisfied in the 10-12% range, especially when compared to depressed 2016 results. Twelve percent earnings growth is all that is guided from 2Q16 to 2Q17. There seem to be reasons to hope for an acceleration in the second half of the year, but the high PE does give me some pause. One must also consider the possibility of an acquisition; management seems to make acquisitions every few years, and they have quite a war chest of cash at present.
I’ve already spilled a lot of virtual ink, so I’ll try to keep my closing thoughts relatively short. I’m pleased that we’re seeing a return to growth at Skyworks, and so too – obviously – is the market. That makes me a bit leery that – at current prices – the valuation might be a bit stretched. Still, I think that Skyworks has a great opportunity in front of it: managing the complexities of wireless communication. As some telecommunications markets transition from 2G and 3G to 4G, and as we await 5G domestically in the U.S., Skyworks has an opportunity to increase content in each new generation of phone, due to the increased complexity of successive generations of wireless protocol. Further, as more and more “things” become connected (increasingly including automobiles), the number of places where a Skyworks chip is appropriate expands. The tailwinds benefitting this company are impressive, and execution has been quite good. Customer concentration remains a concern for now, but there’s always the possibility that it could surprise to the upside should, say, the iPhone 8 prove to be a must-have item. I remain a bull, but current prices make me a cautious one.
Thanks and best wishes,
TMFDatabaseBob (long: SWKS, TSLA; AVGO is on my watch list, but I have a lot of semiconductor companies)
See my holdings here: http://my.fool.com/profile/TMFDatabasebob/info.aspx
Peace on Earth