Last quarter marked the first earnings conference call with Liam Griffin as Chief Executive Officer (CEO). This quarter marked the first earnings conference call with Kris Sennesael as Chief Financial Officer (CFO). One could certainly argue that this means the executive team is pretty green. CFO Sennesael is indeed new to the company, but this is not his first stint as a CFO. CEO Griffin has never been a CEO before, but he has been with Skyworks since 2001 and it sounds as if the company has been grooming him to become the CEO over the last four years or so. From his bio on the Skyworks website: “Prior to his appointment as CEO and to the board of directors in May 2016, he had served as president since May 2014. He served as executive vice president and corporate general manager from November 2012 to May 2014, where he was responsible for all of Skyworks’ business units.” Former CEO David Aldrich, who was Skyworks CEO since its creation in 2002, is still nearby – he is Chairman of the Board of Directors.
Skyworks’ actual results were better than expectations. Likewise, guidance was better than expectations. To add icing to the cake, cash flow from operations and free cash flow set records. I’m not sure why this earnings report wasn’t better received. Or maybe the market wasn’t completely focused on earnings when it thought about Skyworks. We’ll explore that possibility, but first let’s look at the quarterly report.
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/4019314-skyworks-solutions-s…. (Thanks, Seeking Alpha.) Unless stated otherwise, all italicized quotations are from the Seeking Alpha transcript.
4Q16 Revenue: $835.4 million Revenue declined 5.2% from 4Q15, but was up 11% sequentially. Sales to Apple are still depressed, although CEO Griffin thinks they’ll be back on track starting at the end of calendar year 2016. Looking at the table below, you can see that seasonal factors played a role, but this quarter’s result is better than a typical seasonal increase. Wall Street expected $830.9 million and guidance was $826.9-834.4 million.
FY16 Revenue: $3.288 billion Revenue grew ever so slightly, up 0.94% from FY15.
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%
4Q16 Gross Margin: 50.8% GAAP and 51.0% non-GAAP Non-GAAP gross margins hit management’s guidance. The difference between the GAAP and non-GAAP figures decreased partially because of favorable adjustments on acquired inventory, but mostly due to lower stock-based compensation embedded in “cost of goods sold” (COGS).
4Q16 Operating Margin: 34.9% GAAP and 38.1% non-GAAP Operating margin improved nicely from last quarter (31.7% GAAP and 36.5% non-GAAP) and last year’s fourth quarter (33.8% GAAP and 38.1% non-GAAP). The largest part of this improvement came from a reduction in R&D expenses. Reduced stock-based compensation also played a role.
4Q16 Net Income: $246.8 million ($1.31 per diluted share; $1.47 non-GAAP) This is an improvement from both last quarter’s $185.0 million ($0.97 per diluted share; $1.24 non-GAAP) and 4Q15’s $229.2 million ($1.18 per diluted share; $1.52 non-GAAP). Management had guided towards $1.43 in non-GAAP earnings per share, and Wall Street expected the same amount.
FY16 Net Income: $995.2 million ($5.18 per diluted share; $5.57 non-GAAP) Last year’s corresponding figures were $798.3 million ($4.10 per diluted share; $5.27 non-GAAP). As I indicated earlier, full year revenue was up by less than 1%, so one might not have expected this much difference in profits. There were two main causes, and the effects are almost evenly split. The slightly more impactful change from last year was the one-time PMC-Sierra merger termination fee of $88.5 million, which affected GAAP results only. The second change – though perhaps the more important one – was an improvement in gross margins, likely due to the declining sales of the lower-margin power amplifier segment. COGS was $80 million lower in 2016 than in 2015, despite the small rise in revenues. Partially offsetting this were operating expenses, which were $15 million higher than last year.
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 ~$0.47 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
4Q16 Cash Flow From Operations (CFFO): $455 million; Capital Expenditures (CapEx): $16 million; Free Cash Flow (FCF): $439 million These are stunningly good CFFO and FCF numbers. Each is a record. 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%. The CFO credited “… high profitability and significant improvements in working capital.” I’ll say! Although he’s got a funky accent (he was educated in Belgium, and probably raised there), this new guy sure knows how to win friends! CFO Sennesael specifically called out two items that helped improve CFFO. The first was a reduction in “DSO”, which stands for “days sales outstanding” and is a measure of how quickly the company is turning its accounts receivable (billings for products they’ve shipped) into cash. The second is a reduction in “days of inventory”, which gives a sense of how quickly inventory is being turned into sales (or, basically, into accounts receivable). CFO Sennesael predicted further drops in inventory, both in an absolute sense and relative to sales, during 1Q17. This is in keeping with past management commentary about their deliberately building up inventory for known product ramps in the second half of the year. It could also be consistent with typical corporate policy (i.e., not just Skyworks) of polishing up the balance sheet in anticipation of an acquisition. More later. This quarter’s CapEx spending is also unrealistically low, leading to inflated FCF.
1Q17 Guidance Management expects Q1 revenue to increase sequentially by 7-9%, or be in the range of $893.9-910.6 million (a “902” midpoint was referenced several times in the earnings conference call transcript). Non-GAAP earnings are expected to be $1.58 per share. Non-GAAP gross margin is expected to be 51%. This guidance exceeded Wall Street’s estimate of revenue and non-GAAP earnings of $892.5 million and $1.56, respectively. Even the high end of revenue guidance predicts a 1Q17 result below Skyworks’ record 1Q16 result, but management reiterated the expectation that year-over-year revenue growth would resume in 2Q17. As I noted last time, that’s hardly impressive because 2Q16 offers such a low hurdle. Thinking ahead to Q2, though, one should note that it is seasonally Skyworks’ weakest quarter of the year. In 2012-15, the Q1-Q2 decline averaged 6%. If we take it back to 2010-15, the decline averages 5%. I think the 2016 16% decrease is an outlier that should be ignored looking forward. Given the “902” midpoint for Q1 and adjusting only for normal seasonality, we should expect something like $852 million for 2Q17 revenue, which will compare decently (10% growth) against 2Q16’s $775.1 million.
Looking further out, management suggested that full fiscal year 2017 CapEx spending would be in the $200-220 million range. CFO Sennesael indicated that he believed that Skyworks could improve gross margins by 100 basis points by the end of fiscal 2017. Given that they’re at 51% today and that the prior CFO had talked about a 53% intermediate-term goal, setting a next-year goal of 52% seems pretty good.
Cash, Cash Equivalents, and Investments: $1.08 billion The company is currently debt free. The significant rise in cash from last quarter is largely due to the great CFFO number, and comes despite ~$200 million of share repurchases (3 million shares averaging $66) and buying Panasonic’s remaining 34.1% share of the filter joint venture for $76.5 million.
SWKS earnings day share price: $75.07 +0.54% (vs. S&P 500 +0.17%) I’m not sure why this report didn’t garner a bit more love.
1000 Days of Ratios Analysis
The analysis is based 1000 trading days ending November 4, 2016 with a closing price of $75.07. TTM stands for “Trailing Twelve Months”.
Current Price to Earnings Ratio: 15.91x (best 13% – range is 12.38x to 35.23x)
Current Price to Sales Ratio: 4.39x (worst 45% – range is 2.34x to 7.59x)
Current Price to Free Cash Flow Ratio: 17.55x (best 29% – range is 12.69x to 34.84x)
25% P/E cut-off ratio is 17.64x. TTM earnings per share are $4.72. P/E-based target is $83.25.
25% P/Sales cut-off ratio is 2.84x. TTM sales per share are $17.12. P/Sales-based target is $48.61.
25% P/FCF cut-off ratio is 17.33x. TTM FCF per share is $4.28. P/FCF-based target is $74.13.
Suggested Attractive Price: $68.66
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, roughly half the data base is from before the joint venture. 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 3Q16 results was $57.96; the market consistently traded above that price after 3Q16 earnings were released.
Product Mix Across Market Verticals
I was a little dismayed that management did not include this break out of revenues in their prepared remarks. Fortunately, one of the analysts picked up on the omission, requested the data, and management offered numbers, although they may have been a rough estimate. I hope management will return to reporting on this regularly. I’ll call Investor Relations and request that. Maybe it will help.
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%) Year-over-Year Growth 1Q 2Q 3Q 4Q 2015 -32% 2016 -41% -44% -38% -29%
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%) Year-over-Year Growth 1Q 2Q 3Q 4Q 2015 86% 2016 53% 26% -4% -4%
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%) Year-over-Year Growth 1Q 2Q 3Q 4Q 2015 8% 2016 10% 16% 17% 8%
I’m a little disheartened to see the string of increasing growth rates for Broad Markets broken, but I don’t want to read too much into it since I think the market vertical sales percentages were estimates. Last quarter, I highlighted the fact that the declining – deliberately so – Power Amplifier business is an ongoing headwind to revenue growth. The smartphone business – especially Apple’s business – is good, but adds a lumpiness to Skyworks’ revenue growth profile. Acquisitions also provide an occasional kicker. I think these facts are key to understanding Skyworks, and bear repeating.
Returning Money to Shareholders
Skyworks has previously stated a policy (which I liked) of returning 40% of free cash flow (FCF) to shareholders via dividends and share repurchases. It seems as if that policy has gone by the wayside. At this point, perhaps shareholders are rejoicing because they’re currently getting more than 40%, and cash in Skyworks’ coffers is still rising. In Q4, approximately $200 million was spent on share repurchases, and another ~$50 million on dividends. “… Skyworks returned 81% of our free cash flow, or $727 million, to our shareholders over the fiscal year, up from the 64% distributed in fiscal 2015.” Although the higher returns to shareholders feel good in the short term, I want to be sure that Skyworks is performing enough R&D and making enough CapEx investment so they don’t fall behind their rivals.
Other Random Musings
Bulk Acoustic Wave Filters
CEO Griffin seems to continue to back away from former CEO Aldrich’s direction of bringing BAW filter technology in-house. As a reminder from previous posts, BAW filters are higher cost than SAW (surface acoustic wave) or TC-SAW (temperature-controlled SAW) filters, but the technology is such that filtering high-frequency bandwidths can only be done using BAW. Skyworks has done a good job of increasing the bandwidths that TC-SAW can address, but they still need to buy BAW filters for inclusion in some of the products they sell. Bringing additional TC-SAW capabilities in-house (e.g., the Panasonic joint venture and subsequent investments in SAW-based filter technology) has proven good for Skyworks’ business, so the direction of bringing BAW capabilities in-house is understandable. But current CEO Griffin seems to prefer other investments, and is willing to continue buying BAW filters from foundry partners. In answer to an analyst question, he seemed to hold out the hope that Skyworks could continue to advance TC-SAW and encroach upon frequencies previously only addressable by BAW. He mentioned that aspects of time-division duplexing (TDD) – as opposed to frequency-division duplexing (FDD) – enable such advancement. “… what we’re seeing is that there’s more and more TDD capability in 5G than FDD. So when you go to TDD, time division duplexing, you don’t require a BAW filter or BAW duplexer. You can do it with TC …” I’m not familiar enough with this part of the technology to have an opinion yet, but it is something about which I’ll try to learn more. I DO know that the 5G standard hasn’t been finalized yet, although I wouldn’t be surprised if agreement around certain aspects of 5G has begun to coalesce. I also understand that 5G is unlikely to be deployed until 2020, and those initial deployments probably won’t be wide in scope. Still, it sounds as if CEO Griffin doesn’t want to make a major investment in BAW production because he feels that its future is limited, and he has access to the supplies he needs in the near-term.
Mergers and Acquisitions
Several analysts on the call asked questions about Skyworks’ appetite for M&A, as well as aspects that Skyworks might be looking for in a target company. In my experience, such questions will be posed to the management team of any company sitting on over $1 billion in cash. However, in this case there were probably more immediate reasons to ask questions. On October 21, StreetInsider reported that Microsemi (ticker: MSCC) was putting itself up for sale. You may remember Microsemi – they were the company that outbid Skyworks for PMC-Sierra. Outside of the PMC-Sierra business, it is my understanding that Microsemi specializes in “hardened” chips – the kind that can be used in extreme environments like fighter aircraft, rather than air-conditioned server rooms. On November 2, StreetInsider reported that Skyworks exhibited interest in Microsemi and that Microsemi is now working with investment bankers to find other companies that might be interested. I am not going to put too much effort into studying Microsemi unless the likelihood of a Skyworks deal increases. I remember giving Microsemi’s financials a look-over during the bidding war for PMC-Sierra. I wasn’t very impressed. They were carrying a fair amount of debt before the deal. Microsemi paid for PMC-Sierra with a mix of cash and stock, and more debt was taken on to finance the cash portion. I wasn’t convinced that the cash flow of the combined company was going to be sufficient to easily service the debt, so I’m not terribly surprised that the company is up for sale just one year later. What baffles me is why Skyworks is interested, unless they have a real strategy for what they want to do with PMC-Sierra. At the time, most Wall Street analysts and financial press didn’t think the Skyworks-PMC-Sierra deal made sense. Skyworks gave the impression, at the time, that movement toward the data center and storage was driven by customer roadmaps (to which Skyworks generally has decent access).
In answering the analysts’ questions, neither Microsemi nor PMC-Sierra were mentioned. Management stressed their disciplined approach to M&A (amply evidenced by refusing to keep raising their bid for PMC-Sierra) and pointed to some of the M&A successes they had in recent years, adding products or features that helped raise Skyworks to a solutions supplier, rather than just a components manufacturer. “… we would like to have the kind of acquisitions that really raise the overall franchise, that bring us into new technology opportunities that perhaps augment our strength already in the positions in the market that we enjoy today.” When asked about diversification as a goal in M&A, CEO Griffin downplayed it as “… nice in some cases …”, but it sounded as if the main goal was to find “… opportunities that really help us advance our core business.”
As I mentioned earlier, both results and guidance were good. Muted stock market reaction was a bit of a surprise to me, but I wonder if it mostly stems from the fairly-fresh rumor that Skyworks is interested in buying Microsemi. I don’t have strong opinions about the acquisition yet, but I’m amused by the thought of them buying the company only to sell off the non-PMC-Sierra parts (or, alternately, arranging a deal with another company interested in Microsemi who would be willing to sell the PMC-Sierra piece). But let me stop there and tackle a different topic.
I find that my perception of Skyworks (and other companies) is colored by how well the stock has performed for me. I recognize that this is a human foible that shouldn’t be entertained while investing. I can’t shake the foible entirely, but the best antidote I know of is to take a good look at what we can expect from the company going forward, and compare that to the stock’s value today. I’ve touched on several of the points already in this write-up, but I’ll recap them and try to tie things together in a neat little package.
I think we can expect mid-teens revenue growth and perhaps better earnings growth as gross margins improve. One thing that might slow earnings growth is increased R&D expenses, which have been light for a tech company the past few years. Another thing that might ding GAAP earnings is acquisition costs, although they would be excluded from non-GAAP earnings. Whether the target is Microsemi or someone else, Skyworks buys related companies every few years, and we can expect that to continue. I think that a mid-teens organic revenue growth rate is easily supported by the markets that Skyworks serves, principally smartphones and connectivity for “Internet of Things” things (and other “broad market” items). Deliberately declining sales of power amplifiers will provide a headwind against revenue growth, but one that diminishes over time. The mid-teens growth is unlikely to be smooth, as it will be affected by product cycles at major customers, as well as acquisitions.
Increasing complexity benefits Skyworks. Although things are getting easier and easier for users, that means that complexity is forced into the innards of the computer. The content that Skyworks puts into a 3G phone is much greater than that put into a 2G phone. The same goes for 4G vs. 3G and will eventually be the case for 5G vs. 4G. This seemingly irreversible path of increasing complexity benefits Skyworks because: (1) fewer competitors can design for it; and (2) more content has traditionally meant more revenue per unit. This growth in revenue to Skyworks for each unit sold by their customers is another reason I feel comfortable predicting mid-teens revenue growth, if lumpy. China is currently famously moving from 3G to 4G. With less fanfare, Mexico is currently also making the same move. Although most of the population in India that has wireless phones is still using 2G technology, at least one carrier is upgrading their network directly to 4G. I know this from my analysis of a cell tower company.
Share repurchases are likely to decline from their existing levels. I am hopeful that the Skyworks board of directors is emphasizing buybacks now because they feel the company is cheap, and would de-emphasize them if the stock becomes more richly-valued. I believe share repurchases would virtually disappear for a while – in favor of paying down debt – should Skyworks make a major acquisition.
The balance sheet is a fortress. The company has $1.08 billion in cash. There is no long-term debt, and the “other long-term liabilities” line item is just over $100 million. While the company has $940 million in goodwill and intangible assets, that amount pales in comparison to over $3.5 billion in shareholder equity – a very good ratio, in my experience, for such an acquisitive company. Admittedly, the company is one large acquisition away from having a less-than-fortress-like balance sheet. For example, Microsemi has a $5.3 billion market cap (closer to $5 billion if you eliminate the cash on their books). But, given Skyworks’ strong cash flow, debt could be paid down quickly. Skyworks suggested they would take that approach while they were bidding for PMC-Sierra.
I’m a Value Line subscriber, and one thing I certainly pay attention to is their eponymous “value line”. Their value line for Skyworks recently pegged fair value at about $90. For those fond of ratios that compare earnings growth to PE ratio, and want to see that ratio at or below 1 (you know who you are!), we are ever so slightly below 1 if you look backwards at TTM earnings, but look forwards at an expected growth rate in the mid-teens (i.e., 15.9 PE ratio vs. 16% expected growth). Of course, if you look backwards at year-over-year revenue and earnings growth rates, Skyworks looks like a mess because revenue growth has been flat-to-negative for the past three quarters and we’re likely to see one more negative quarter before we turn the corner. Primarily due to lower revenues, recent earnings growth has been anemic and irregular. But I think that extrapolating that one-year decline out into the future is almost as erroneous as extrapolating out into the future the gains that occurred during 3Q14-4Q15.
I don’t believe Skyworks is broken, but we do need to recognize that it is in a volatile industry, and that it brings some amount of volatility (or lumpiness) upon itself through its customer concentration and its predilection for acquisition.
Thanks and best wishes,
TMFDatabaseBob (long: SWKS)
See my holdings here: http://my.fool.com/profile/TMFDatabasebob/info.aspx
Peace on Earth