It would be facile to haul out an aphorism like “Apple sneezes and Skyworks Solutions catches a cold.” But it wouldn’t be entirely appropriate. Yes, Skyworks might have produced better results if their largest customer were currently in better shape. But they were able to grow both revenues and profits despite that important headwind. The market took SWKS down, though, because guidance for the third fiscal quarter was below Wall Street’s expectations, which seem predicated on an assumption that “inventory adjustments” would be purely a second quarter phenomenon. It sounds as if they’ll be with us a bit longer. But management sounds optimistic about the second half of the calendar year.
My apologies that this report is so delayed.
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/3969435-skyworks-solutions-s… (Thanks, Seeking Alpha.) Unless stated otherwise, all italicized quotations are from the Seeking Alpha transcript.
2Q16 Revenue: $775.1 million Revenues eked out a 1.7% gain over last year’s first quarter and hit the bullseye with regards to management’s guidance. Wall Street expected $775.8 million. Revenues were down significantly sequentially. This was widely expected however (and factored into current stock prices), given that Apple is Skyworks’ top customer, and Apple’s current slowdown is no secret.
2Q16 Gross Margins: 50.4% GAAP and 50.8% non-GAAP Management had guided to 50.5-51.0% non-GAAP gross margins.
2Q16 Operating Margins: 33.2% GAAP and 36.8% non-GAAP Management did a great job of reining in expenses as sequential revenues declined.
2Q16 Net Income: $208.1 million ($1.08 per diluted share; $1.25 non-GAAP) Net income increased 25% year-over-year, which is an impressive feat given the slight revenue increase. Cost of goods sold decreased 6%, despite the increase in revenue. Operating expenses were essentially flat, rising less than a quarter of a percent. Management had guided towards $1.24 in non-GAAP earnings per share and Wall Street expected that same amount.
2Q16 Cash Flow From Operations (CFFO): $154.5 million Cash was marshalled through working capital management and reined-in capital expenditure (CapEx) spending. Free Cash Flow (FCF, which subtracts CapEx from CFFO) is $117.5 million. Given management’s stated goal of returning 40% of FCF to shareholders in the form of dividends and share repurchases, we’d ideally like to see quarterly FCF above ~$124 million (40% of which would cover the dividend payment).
3Q16 Guidance Management expects revenue to be $750 million and non-GAAP earnings to be $1.21 per share. Non-GAAP gross margin is expected to be 51% and the company hopes to hold operating expenses roughly flat from Q2 levels. Wall Street was probably taken by surprise here, as they expected revenues of $803 million and non-GAAP earnings of $1.32. Last year’s 3Q results were $810 million in revenue and $1.34 in non-GAAP earnings, so it sounds as if we’re likely to see a decline during what normally would be a seasonally-strong quarter.
Cash, Cash Equivalents, and Investments: $1.18 billion The company is currently debt free. There is slightly less cash than last quarter due to share repurchases, which will be discussed in a separate section below.
SWKS earnings day share price: $66.82 -6.91% (vs. S&P 500 -0.51%) When the market overlooked weak guidance last quarter, it must have assumed it would be a one-quarter deal. With 3Q16 looking weak too, the market probably thought some profit-taking was in order.
1000 Days of Ratios Analysis
The analysis is based on the May 4, 2016 closing price of $65.23.
Current Price to Earnings Ratio: 13.92 (best 1% – range is 12.52x to 35.23x)
Current Price to Sales Ratio: 3.74 (best 48% – range is 2.34x to 7.59x)
Current Price to Free Cash Flow Ratio: 25.91 (worst 24% – range is 12.69x to 34.84x)
Suggested Attractive Price: $59.87
25% P/E cut-off ratio is 18.86x. TTM earnings per share are$4.68. P/E-based target is $88.36.
25% P/Sales cut-off ratio is 2.80x. TTM sales per share are $17.44. P/Sales-based target is $48.82.
25% P/FCF cut-off ratio is 16.85x. TTM FCF per share is $2.52. P/FCF-based target is $42.42.
Last quarter, this analysis deemed prices below ~$57 attractive. Surprisingly, this price was attainable during the time since the last earnings report. Regardless of whether you used this analysis, I hope you were able to buy SWKS at attractive prices earlier this year. I would still caution you that Skyworks’ acquisition of the Panasonic division (more on that in another section) means that a fair amount of the historical data base used for this analysis may not provide meaningful comparisons, so the analysis could very well be flawed. I continue to present it because it will get better each and every quarter (unless we see another transformative acquisition), and so you can familiarize yourself with how it performs over time. I also want to note that the wide range of current target values based on each of the three ratios suggests to me that something is amiss, and not much weight should be given to this analysis right now. We’ll all see together how it evolves over time.
Product Mix Across Market Verticals
Before I go into detail about the growth performance of each of the market verticals, please let me share this synopsis from Chief Financial Officer (CFO) Donald Palette: “We continue to expect IMS to remain our strongest growth segment, followed by broad markets, while power amplifier products continue to decline as a percentage of our revenue as the market shifts towards higher value integrated solutions.”
Power Amplifiers ¶ – This set of products has the lowest gross margins (40-45%) and slowest long-term growth (~5%).
In 2Q16, PA accounted for 17% of revenue, or roughly $132 million. Last quarter, the comparable percentage and amount were 16% and $148 million. In last year’s second quarter, PA was 31% of revenue or about $236 million. As you can see, Skyworks is shrinking this slower-growing, lower-margin, legacy portion of their business, although they haven’t abandoned it. The year-over-year decrease was about 44% while the sequential decrease was about 11%.
Integrated Mobile Systems (IMS) – These “smart phone”-enabling products have better gross margins (~50%) and better long-term growth prospects (15-20%).
In 2Q16, IMS accounted for 58% of revenue, or roughly $450 million. This compares to 64% of revenues, or roughly $593 million in 1Q16 and 47% of revenues, or roughly $358 million in 2Q15. This part of the business grew roughly 26% year-over-year, although it shrank 24% sequentially.
IMS is currently the source of Skyworks Solutions’ greatest customer concentration. Their largest customer is Foxconn, which represented 44% of revenue in FY15. Although I had initially equated Foxconn with Apple, I was cautioned by a respected in-house TMF analyst that Foxconn manufactures smart phones for several providers. I think it is safe to say at this point that Apple is Skyworks’ largest customer, Samsung is #2 (although it dropped below being a 10% customer in FY15), and Huawei has emerged recently as the solid #3 customer. Customer concentration is a risk for Skyworks (as evidenced in the most recent quarter). The clearest path to reduction of customer concentration is through increased sales into “Broad Markets”.
Broad Markets – A catch-all category 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), with gross margins exceeding 50% and long-term growth rate exceeding 20%.
In 2Q16, Broad Markets accounted for 25% of revenues, or roughly $194 million compared with 20% of revenues, or roughly $185 million in 1Q16 and 22% of revenues, or roughly $168 million in 2Q15. Growth year-over-year is 18% (per Chief Executive Officer (CEO) David Aldrich), while sequential growth is ~5%.
Returning Money to Shareholders
It is Skyworks Solutions’ stated policy that they expect to return 40% of free cash flow (FCF) to shareholders via dividends and share repurchases. Let’s see where we stand with respect to that this quarter.
2Q16 FCF was $117.5 million, and 40% of that is $47 million.
The second quarter dividend consumed $49.3 million. This is down from $49.8 million last quarter because share repurchases reduced the number of shares outstanding at the time of the dividend. But it is still above the $47 million that represents 40% of FCF.
Additionally, during the quarter, Skyworks bought roughly 2 million shares at an average price of $67.55, or $135.1 million (with commissions).
Chief Financial Officer (CFO) Donald Palette had this to say about share repurchases: “Given our confidence in our long-term business trends, we expect to continue to be very active with our share repurchase activity at current [share price] levels.”
The share repurchase plan authorized by the board of directors has $264.9 million remaining.
Looking at the first half of the fiscal year, FCF was $382.9 million, so 40% is $153.2 million. Dividends for the six months were $99.1 million and share repurchases totaled $135.1 million. Last quarter, I had described Skyworks as being “in arrears” with respect to their target of 40%, although I noted that it’s just a general guideline, not a rule applied each and every quarter. Well, Skyworks is now far ahead of their 40% objective.
I find it interesting to note that the diluted share count declined a lot more than the basic share count, which tells me that employees purchased a fair number of shares (or exercised options) this quarter. Compared against calendar year-end numbers, the weighted average basic count declined from 190.4 million to 190.2 million, while the weighted average diluted count dropped from 194.7 million to 193.3 million.
Favorite Quote of the Conference Call
CEO Aldrich: “… I want to take just a moment to reiterate a couple of the more significant drivers that we see fueling our growth in the coming years. First is the Internet of Things. This opportunity is measured in the tens of billions of units, and projected to grow at an 83% CAGR through 2020. And our success here has been borne out by a broad and a growing list of wins in new markets like automotive, medical, industrial, wearables and the smart home. Today we participate in all of these verticals…
The second major growth theme for us is the skyrocketing demand for data, wireless data, which is being fueled by a growing number of new applications like streaming media, like mobile advertising, virtual reality, and cloud-based services across consumer and enterprise applications. These services are all in their infancy, and they consume a tremendous amount of bandwidth, drastically increasing demands on networks and on devices. As sophisticated as today’s devices are, they’re simply not good enough to support the immense data requirements of these types of new applications, which will be rolling out over the next few years. To address this performance gap, OEMs today are implementing techniques like carrier aggregation, receive diversity, MIMO and ultimately 5G, which require dramatically higher levels of analog performance at the semiconductor level. As a technology enabler to these system upgrades, our addressable content per device is rising, driving TAM growth well in excess of the broader semiconductor space.
Both of these secular growth themes are playing out for us… And we’re capitalizing by combining a strategic focus on higher value added integrative solutions with unrivaled scale, advanced manufacturing capabilities, and a deep system level knowhow. This is the key reason that we are consistently delivering among the best financial returns in the semiconductor sector, in a variety of market conditions.”
FilterCo (Panasonic Division) Purchase
The information in this section comes from Skyworks 10-K filing with the SEC.
FilterCo is the name attached to the joint venture entered into by Skyworks Solutions and Panasonic. As I’ve noted before, one could argue that – instead of a joint venture – Skyworks bought majority control (66%) of an existing Panasonic division. Subsequently, both companies have infused the division with funds and technology. What is interesting here is that we are coming up on the two-year anniversary of the deal in August 2016. At that point, Skyworks has an option to buy the remaining 34%. Skyworks clearly stated their intention on page 76 of the 10-K: “we plan to exercise.” In fact, on page 92, they indicated that they have already hedged their yen exposure for the purchase.
How will this affect Skyworks’ financial statements? As best as I can tell, other than removing the cash paid from Skyworks’ books, the financials won’t change at all. Page 106 includes this nugget: “As a result of the purchase option, the company consolidates 100% of FilterCo’s operations.”
Not that this is a big deal, but the original Panasonic employees are covered by a Defined Benefit Pension Plan, which Skyworks will adopt; the plan has been frozen and new employees are not eligible. Most Skyworks employees are covered by a 401(k) plan instead of a pension. The pension at FilterCo is currently underfunded by a little more than $5 million, an immaterial amount for Skyworks.
It isn’t clear to me how much Skyworks will pay Panasonic in August, but, after Skyworks and Panasonic agreed to add working capital to the division last October, Skyworks’ share of the division was valued at $240 million. So I’d guess the purchase price for the remaining 34% will be north of $120 million.
Other Random Thoughts
According to the 10-K, Skyworks’ federal tax returns for FY12 and FY13 are currently being audited by the IRS. A prior audit of FY11 taxes caused a tax increase, but the increase was by less than $3 million. For comparison, the amount that Skyworks provisioned for U.S. federal taxes in FY15 was almost $200 million.
Second Half Optimism
CEO Aldrich notes: “… I suspect as you go through the second half of 2016 it will be much more positive. We’ll start to see strong sequential growth in 2017. I do absolutely see growth in the overall RF and analog TAM being double digits year over year.”
Company President Liam Griffin expects “significant incremental gains” year over year. Later during the Q&A, he added, “So China, for example, in Q2 we were up about 14% sequentially. We think year over year when we finish FY 2016, China will be up about 20% to 25%.” This is significant, as China represented fully 69% of Skyworks’ sales in FY15.
A Leading Online Retailer
I can’t take credit for catching this; it was Saul who noted it. Although it wasn’t listed in the “Business Highlights” section of the press release, in his prepared remarks during the conference call, CEO Aldrich slipped an additional item in among items from that list. “… we landed new opportunities which include … a new connected home hub for a leading online retailer, …”. If he’s alluding to Amazon’s Echo, that would indeed be an intriguing opportunity, although it is pure speculation at this point.
In my closing remarks last quarter, I described Skyworks as resilient in the face of an Apple slowdown. That commentary is as apt today as it was then. Hopefully it will remain so next quarter, despite guidance towards year-over-year revenue and earnings declines during what would normally be a seasonally-strong quarter.
Thanks and best wishes,
TMFDatabaseBob (long: SWKS)
Peace on Earth