I am going to post my November 2015 “SWKS earnings and analysis” almost in its entirety and very lightly edited. It was my first attempt at an in-depth analysis of Skyworks. As such, I’ve included comments where I “introduce myself”. I’ve left that commentary intact so I can introduce myself here as well (and I need to thank both Matt and PuddinHead42 for their kind words in introducing and welcoming me on this board).
A few things have happened since this post that I should note. In the post, I talked about my semiconductor holdings. I have added NXPI to the list, and I’ve also increased my SWKS holding to the point it is a top 10 holding rather than merely top 20. That occurred when it became clear to me that Skyworks wasn’t going to overpay for PMC-Sierra. (BTW, NVDA is also in my top 10, purely due to price appreciation since January 2004.)
My subsequent earnings analysis (for FY16Q1) was selected as “Post of the Day”. It was highlighted as such on this board back then, so I won’t repost it, but will include a link: http://caps.fool.com/Blogs/skyworks-quarterly-earnings/10667…
You’ll also note that I have a decided preference for GAAP earnings over non-GAAP earnings. Saul and I have had discussions on other message boards on this topic. I recognize that GAAP has limitations, but I don’t dismiss it because of them. I think we’re better off using both. I hope no one finds it too unsatisfying, but I don’t intend to engage in a GAAP v. non-GAAP debate at this point, no matter how temptingly baited. Maybe another day… For now, it is a higher priority for me to go back into “silent mode” on this board for a while. As stated before, I want to bring myself up-to-date on this board’s important posts. I also need to prepare for the coming earnings season, which is almost upon us (Skyworks will report on Thursday, April 28 after market close). Thorough analysis requires some preparation, right?
Sorry in advance, the post below was already a long one, and now I’ve made it even worse here with this bloated introduction… Despite this post’s age, I think the points are largely still relevant. I know my excitement hasn’t diminished…
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Hello Skyworks Solutions shareholders and followers. This is my first earnings analysis for this company, so please indulge me while I briefly explain who I am and my background with SWKS. Then I’ll do my best to cover the company’s quarter. It’ll be a rookie effort, but I’m sure my coverage will improve as time goes on.
I was born and raised in New York City and grew up fascinated by the stock market. My undergraduate degree is in mathematics and computer science from Queens College, CUNY. I have an MBA from NYU-Stern and a decent background in accounting, although I’ve never been a manager or an accountant. I’ve worked for several of the Wall Street brokerage firms, but always as a database engineer (hence the “database” in my handle). I’ve since moved to Boulder, CO. I started subscribing to the Motley Fool more than ten years ago because I felt they had a better handle on some of the smaller, racier companies than the advisory service I was using at the time. My posts tend to be long, but I hope you’ll find them well-organized, informative, and occasionally amusing.
Over time, I’ve built a diversified portfolio with about 80 individual stock holdings plus some mutual funds. As I look at it, I realize that I have a fair number of chip manufacturers, including AMBA, CY, INTC, INVN, NVDA and SWKS, so it probably behooves me to learn more about the industry. SWKS is currently among my top 20 holdings. In late 2014, I purchased a position half-again as large as my usual initial position, but propulsion into the top 20 has come from share price appreciation. I’ve been impressed with that growth – and the market opportunity ahead of the company – and was tempted earlier this year to make an additional purchase which would have made SWKS a top 10 holding for me. Before I could act, the PMC-Sierra deal was announced, which made me want to step back and reassess. I still may make an additional purchase, once TMF trading restrictions expire, as I’m growing more comfortable with the pending PMCS acquisition. I’m not describing my holdings as an example for anyone to follow; I’m merely trying to make it clear that I have skin in the game. That might make me biased, but certainly makes me interested. My computer science background may help me a little in understanding and explaining this company, but please don’t consider me an “expert”. My background is more in software than hardware, and it is very database-specific. But my lack of expertise may prove beneficial, since I will be forced to explain the concepts I learn in layman’s terms, being a layman myself. In the TMF community, we all learn from one another. Hopefully I can add to the community’s understanding of SWKS while I learn about other companies from other contributors. Introductions out of the way, let’s dig in.
You’ll note that this is a fourth quarter and full year earnings report. Skyworks Solutions’ policy is to choose the Friday closest to September 30 as its fiscal year end. This leads to some fiscal years containing 53 weeks, while others contain 52. FY14 was a 53-week year and FY15 was a 52-week year. I doubt you’ll detect any weakness from the missing week.
I’ll typically refer to the company as “Skyworks Solutions” or just “Skyworks”, and use the ticker “SWKS” when I want to refer to the stock. Keeping the distinction between “stock” and “company” in mind is an aid towards long-term thinking, which I think you’ll find beneficial to wealth-building.
Skyworks Solutions and SWKS have been on a remarkable tear. The company has grown earnings and revenues quite nicely since 2014, and the stock followed suit. This quarter’s results seem to maintain the upward trajectory, although absolutely awesome revenue growth seems to be slowing down to merely remarkable growth. For the three consecutive quarters ending from September 2014 to March 2015, Skyworks investors were treated to year-over-year revenue gains that exceeded 50%. That pace has slowed in the June and September 2015 quarters to 38% and 23%, respectively.
Although I’m still trying to learn more about the company’s history, it appears that the 2014 joint venture with Panasonic to produce SAW (surface acoustic wave) and TC (temperature-controlled) SAW filters was a transformative event for Skyworks. Although it is described as a joint venture, it could also be argued that Skyworks bought a controlling interest in part of a Panasonic division. Slowing revenue growth seems to coincide with the anniversary of the announcement of the transaction.
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/3654806-skyworks-solutions-s… (Thanks, SeekingAlpha.) Unless stated otherwise, all italicized quotations are from the Seeking Alpha transcript.
4Q15 Revenue: $881 million Revenues were up 23% over last year’s fourth quarter. Per Yahoo! Finance, Wall Street analysts expected $877 million in revenue. Management had guided towards $875 million when third quarter results were released, and revised it to $880 million during the PMC-Sierra conference call.
FY15 Revenue: $3.258 billion Revenues were up 42% over last year. This appears to be the sixth consecutive year of record full year revenues, dating back to when Skyworks emerged from the financial crisis.
4Q15 Gross Margins: 49.5% GAAP and 50.0% non-GAAP I much prefer to focus on GAAP (Generally-Accepted Accounting Principles) results, but (1) management only offers non-GAAP guidance, and (2) the two figures are not hugely different, at least currently. The difference is that non-GAAP excludes stock-based compensation and acquisition-related costs. Since Skyworks is fairly acquisitive and regularly uses stock-based compensation, I don’t see why those costs should be excluded, other than that “everyone else does it”. Hopefully that will be my last GAAP v. non-GAAP rant on this board for a while. I’ll continue to report both numbers. Management had guided to 50% non-GAAP gross margins for this quarter when earnings were released last quarter.
FY15 Gross Margins: 47.7% GAAP and 48.2% non-GAAP
4Q15 Operating Margins: 33.8% GAAP and 38.1% non-GAAP Management had guided towards non-GAAP operating margins above 38%.
FY15 Operating Margins: 31.4% GAAP and 36.0% non-GAAP These operating margins are pretty exemplary. For comparison, Intel’s FY14 GAAP operating margins were 27.5% and NVIDIA’s operating margins for FY15 were 16.2%.
4Q15 Net Income: $229.2 million ($1.18 per diluted share; $1.52 non-GAAP) Net income and GAAP earnings per diluted share are both 31% above last year’s fourth quarter. Non-GAAP earnings are up 36%. The difference between GAAP and non-GAAP is largely due to stock-based compensation and tax adjustments. Wall Street expected $1.52 per share in non-GAAP earnings. Management had guided towards $1.51 in the 3Q15 earnings report and adjusted it to $1.52 during the PMC-Sierra conference call.
FY15 Net Income: $798.3 million ($4.10 per diluted share; $5.27 non-GAAP) Full year net income is an amazing 74.4% higher than last year. This appears to be the third consecutive year of record full year net income.
4Q15 Cash Flow From Operations (CFFO): $233 million Let me utter a small “boo-hiss” that Skyworks does not include a statement of cash flows in its earnings press release (and the 10-Q isn’t typically filed with the SEC until days later). That said, Chief Financial Officer (CFO) Don Palette does routinely disclose the numbers that I find most interesting during his prepared remarks. Free Cash Flow (FCF – which subtracts CapEx from CFFO) was $82 million, due to relatively high CapEx spending. This quarter’s CFFO result is Skyworks’ second-best ever, while the FCF figure is below average.
FY15 Cash Flow From Operations (CFFO): $993 million This is the third consecutive year of record CFFO. FY15’s CFFO was about 29% above FY14’s CFFO.
1Q16 Guidance “… we anticipate revenue between $925 million and $930 million, with non-GAAP gross margin in the range of 51 percent. We forecast non-GAAP diluted earnings per share of $1.60.” (from the earnings press release)
Longer-term Guidance As recently as early this year, management described 50% non-GAAP operating margins as a long-term goal. By 3Q15, management realized that they needed to update their long-term model. This quarter, that update was offered. “… within a six-quarter to eight-quarter period, we are targeting organic annualized EPS of $8 at a revenue run rate of around $4.5 billion with gross margins in the 53% range. Longer term, based on our internal margin initiatives, we are driving the business towards gross margins in the 55% range on an organic basis.”
Cash, Cash Equivalents, and Investments: $1.04 billion The company is currently debt free, although there are long-term obligations of under $100 million. Business items like capital leases and required future royalty payments fall into this category.
SWKS earnings day share price: $85.99 +7.11% (vs. S&P 500 -0.03%) It was nice to see the upside movement, despite the fact that the earnings report was basically in-line with the guidance given at the PMC-Sierra conference call.
1000 Days of Ratios Analysis
Current Price to Earnings Ratio: 20.99 (best 40% – range is 11.66x to 35.23x)
Current Price to Sales Ratio: 5.14 (worst 26% – range is 1.86x to 7.59x)
Current Price to Free Cash Flow Ratio: 29.74 (worst 7% – range is 9.98x to 34.84x)
This analysis tries to find opportunities where three specific ratios are in the best 25% of “recent” historical values (i.e., the last 1000 trading days, or roughly 4 years of history). The 25% cut-off for PE currently implies a ratio of 19.09x. Based on current trailing twelve month (TTM) earnings, that would mean prices under $78.19 are attractive. Looking at Price to Sales, the multiple at the 25% cut-off is 2.73x. Based on current TTM sales, prices under $45.64 are attractive. Finally, the Price to Free Cash Flow multiple at the 25% cut-off is 16.14x, which would imply that prices under $46.67 are attractive. If we take the average of those three, this analysis suggests that you’d want to wait for a price under $56.83.
Although I am presenting this analysis to you, I want to clearly state that I don’t think you should rely on it for identifying an entry point for SWKS. This analysis works best when all 1000 days of trading history are representative of the company’s business at present. For Skyworks, I don’t believe that’s the case. As I mentioned earlier, I think that last year’s acquisition of a controlling interest in Panasonic’s SAW and TC SAW division may have been a transformative event for the company. As such, roughly two-thirds of the data may not be representative, which seriously degrades the value of this analysis. More than 99% of the “best 25%” data points for the three ratios occurred in the 2011-2013 timeframe. I’ll decide whether it is worth continuing to present this analysis going forward. Will the acquisition of PMC-Sierra be another transformative event? Perhaps this analysis – as useful as it is for some companies – is inappropriate for acquisitive companies like Skyworks. But I wanted to present the analysis to you at least once, and I’m happy to answer your questions about it.
Product Mix
Officially, Skyworks Solutions reports earnings as if they operate as one division. However, each quarter, management partitions sales into three different categories, indicating the percentage of total sales for each and sometimes the growth rate for some of them as well. This quarter, I’ll present the current quarter’s data as well as the data from the prior four quarters, so you can get a historical perspective on this very interesting set of data. Going forward, though, I’ll just report the current quarter.
Power Amplifiers – This appears to be an older business that is becoming less important to Skyworks as each year passes. A recent investor presentation (Corporate Overview – August 2015) noted that PA was 60% of revenues in FY11, but that percentage had decreased to 38% by FY14. Gross Margins are in the 40-45% range, and the long-term growth rate is ~5%.
Integrated Mobile Systems – The easiest way to think of this is “smart phones”. Gross Margins are ~50%, and the long-term growth rate is 15-20%.
Broad Markets – As the name implies, this is kind of a catch-all category that encompasses 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 be >50%, and the long-term growth rate is >20%.
4Q14
Power Amplifiers: 36% of revenue
Integrated Mobile Systems: 39% of revenue
Broad Markets: 25% of revenue
CFO Palette described healthy growth across all categories indicating that Mobile grew fastest and the Broad Markets grew over 30% during FY 14.
1Q15
Power Amplifiers: 31% of revenue
Integrated Mobile Systems: 48% of revenue
Broad Markets: 21% of revenue
CFO Palette again described healthy growth across all categories indicating that Mobile grew fastest and the Broad Markets grew 26% over 1Q14.
2Q15
Power Amplifiers: 31% of revenue
Integrated Mobile Systems: 47% of revenue, up 139% year-over-year
Broad Markets: 22% of revenue, up 27% year-over-year
3Q15
Power Amplifiers: 24% of revenue
Integrated Mobile Systems: 53% of revenue, up 120% year-over-year
Broad Markets: 23% of revenue, up over 20% year-over-year
4Q15
Power Amplifiers: 20% of revenue
Integrated Mobile Systems: 59% of revenue, up 84% year-over-year
Broad Markets: 22% of revenue
Tax Rate
Skyworks Solutions pays a relatively low tax rate. They paid 22.6% during 4Q15 and 22.0% for FY15. Based on last year’s 10-K, this seems to largely arise from non-U.S. sales where tax rates are lower. In FY14, Skyworks registered almost $2.3 billion in sales. About $1.6 billion were in China and $2.2 billion were in Asia. U.S. sales were only about $50 million. In the U.S., Skyworks also takes advantage of the R&D tax credit, when it is available. Should Skyworks succeed in acquiring PMC-Sierra, its tax rate may be lowered further, as PMC-Sierra has net operating loss carryforwards that Skyworks would be able to utilize.
Returning Money to Shareholders
I really like Skyworks’ policy with regards to this. As we’ve seen earlier in this post, Skyworks has good gross margins, exemplary operating margins, no debt, and a low tax rate. These combine not only to produce impressive profitability, but also pretty good cash flow generation – above and beyond the amounts management feels are necessary to grow the business. Skyworks’ policy is that they seek to return 40% of free cash flow to shareholders, using the dual methods of dividends and share buybacks. During FY15, Skyworks doubled their quarterly dividend from $0.13 to $0.26, producing a still-modest yield of 1.2%. During his prepared remarks, CFO Palette noted that Skyworks had returned 64% of free cash flow to shareholders during FY15 – well above target. It will be impossible to know whether Skyworks got good value on the share repurchases until they file form 10-K with the SEC. However, we can draw some inferences based on the 3Q15 10-Q and CFO Palette’s comments during this quarter’s earnings conference call. While it is true that free cash flow is literally Cash Flow from Operations minus maintenance CapEx, very few companies disclose which portion of their CapEx is related to maintenance and which portion isn’t. So, typically, FCF is calculated as CFFO minus CapEx. I think that this year’s FCF is around $560 million, so 64% is around $360 million. As of the end of the third quarter, Skyworks had spent about $75 million on dividends and about $125 million on share buybacks (at an average price of $78.91), for a total of about $200 million. The doubling of the dividend means that Skyworks spent another $50 million on dividends in the fourth quarter. If my $560 million FCF estimate is accurate, that means that Skyworks spent about $110 million on share buybacks in 4Q15 – almost as much as in the first three quarters combined. Given where SWKS prices were in fiscal 4Q15 ($71-107) compared to fiscal 1Q15 ($44-75), 2Q15 ($69-103) and 3Q15 ($91-113), it seems that Skyworks moved aggressively to take advantage of the price decline after prices peaked in 3Q15. I would also note that the doubling of the dividend was a fairly aggressive move. Forty percent of this year’s $560 million is $224 million; committing to a $200 million dividend leaves little room for share buybacks unless Skyworks can grow FCF significantly.
Investment Cycle
I think that it is useful to know where Skyworks is in its investment cycle. It is normal for manufacturers to go through cycles where they expand capacity and then pause until the extra capacity is close to being utilized before building more. Although FY15 CFFO was the highest it’s ever been, trailing twelve months FCF has declined in each of the last three quarters (having peaked in 1Q15). This tells me that Skyworks is deep into an investment cycle. Given the opportunities it has in front of it, I see that as a good thing. During the fourth quarter, it sounds as if they bought equipment for a factory that will help them triple their filter capacity. It sounds as if this factory will not only be able to produce SAW and TC SAW filters, but also BAW (bulk acoustic wave) filters as well. BAW filters are more complex and expensive than SAW or TC SAW filters, but BAW filters are the only technology appropriate for filtering certain wavelengths. Chief Executive Officer (CEO) Dave Aldrich disclosed that Skyworks has leveraged their TC SAW filter expertise, “picking off bands that were previously only addressable by BAW.” That said, CEO Aldrich further disclosed, “… we do see that there are bands that we’re going to need and so between partnerships and our own internal development, we expect to be in production with BAW devices by 2017.”
Closing Thoughts
This post is already very long, but I want to take a few paragraphs to sum up what gets me so excited about Skyworks Solutions. Skyworks has deep relationships with a variety of customers, they have expertise in technologies that support existing and emerging products with huge growth potential, and their competitive advantage is expanding, not contracting. That’s quite an assertion! Let me unpack the individual components.
Deep Relationships
The complexity in connected devices has reached a point where customers are no longer interested in buying components that they can fashion into a solution – they want to buy a solution, preferably customized. Developing solutions, rather than just selling components, is a Skyworks specialty. But developing solutions requires access to customer requirements early in the design cycle. Granting vendors access to upcoming designs requires a lot of trust. As long as the vendor continues to reliably deliver great solutions, the relationship between customer and vendor gets deeper and stickier. Skyworks seems to be managing this well.
Variety of Customers
In a recent podcast, TMF analyst Aaron Bush noted that Skyworks supplies “all of the leading smartphone manufacturers”. That just covers the Integrated Mobile Systems market. Skyworks has many other customers in the Broad Markets and Power Amplifiers markets as well. The FY14 10-K indicated that Skyworks Solutions has over 2,000 customers.
I don’t want to paint an overly rosy picture here, though. There is significant customer concentration. Foxconn (who builds phones for Apple) accounted for 34% of FY14 sales. Samsung Electronics accounted for another 10%. These are relationships that Skyworks needs to make sure are “deep” and “sticky”. Given the Integrated Mobile Systems growth rates that we saw earlier in this report, it wouldn’t surprise me if this customer concentration got “worse” in FY15.
But I think these concentrated relationships are likely to remain stable in the near future. By the time a more distant future arrives, Broad Market opportunities are likely to have reduced the concentration that exists today.
Existing and Emerging Products with Huge Growth Potential
Let’s address “existing” first, since it might be tougher to explain. Can smartphones become more ubiquitous? Actually, they can, because this troglodyte curmudgeon author has yet to own one. And the same can be said for many people in large emerging markets like Brazil, China, and India (except for the “troglodyte curmudgeon” part). But a more critical focus for Skyworks than ubiquity, is feature set. CEO Aldrich points out that mobile data traffic will increase at a 60% CAGR through 2019. I have seen similar statistics mentioned by other companies I follow. Services will need to be upgraded – 4G, LTE, LTE-Advanced, 5G – to handle the exponential requirements, and these service upgrades will require phone upgrades. With each service and phone upgrade cycle, Skyworks is putting more content in each phone. Increasing content implies increasing complexity, which means fewer competitors can deliver solutions. Happy dance for Skyworks!
For “emerging”, I’ll point to several statistics, but my favorite observation is to just consider the Internet of Things. Before I go there, though, let’s consider some specific numbers from the Skyworks Solutions investor presentation. The Compound Annual Growth Rate (CAGR) for wearable devices is expected to be 52% between 2010 and 2018, reaching almost 300 million units at the end of that time frame. The CAGR for connected home technologies (which include smoke detectors, thermostats, alarms, wireless lighting, streaming media, intelligent security and audio systems) is expected to be 67% from 2012-2018, growing to 1.3 billion units. Automotive applications – an area where Skyworks is already gaining significant traction – is expected to grow at a 39% CAGR between 2009 and 2018, with total units approaching 70 million connected cars. Those are impressive growth rates, folks; rates half that good offer strong returns. But I prefer to focus on the Internet of Things. There are far more many things than people, and many of those things could benefit from more intelligence than they currently have. While I have strong faith that the Internet of Things will create some great investment opportunities, I’m not sure I see a clear path to profitability for all companies trying to ride the coattails of the Internet of Things. Skyworks appears to be a likely winner, though. It is less of a pure play, but more of a sure bet because its current approach is profitable and it’s likely to become more so as more and more things are connected.
Competitive Advantage is Expanding, Not Contracting
The switch from supplying components to solutions seems to have caught a chunk of the industry off guard. To quote CEO Aldrich from various points during the Q&A: “we are seeing fewer competitors”, “we’re seeing a narrower competitor base”, “we are broader than any of our competitors at the system level”, and “We are increasingly integrating more functionality as these devices get more complex, and we’re seeing fewer competitors able to do it.” I really don’t think he’s bragging so much as telling it like it is. Large margins attract competitors – no doubt about it. But – for now – Skyworks has a solid lead.
I offer my apologies for such a long post. Next time will be shorter for sure as I dispense with personal introductions and hopefully try to stay more “on point” with the quarter’s results, rather than straying into my general excitement for the investment thesis.
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Fool on!
Thanks and best wishes,
TMFDatabaseBob (long: AMBA, CY, INTC, INVN, NVDA, NXPI and SWKS)
Peace on Earth