Chip company Broadcom (NASDAQ:AVGO) reported its fiscal third-quarter results after the market closed on Sept. 6. The wireless business failed to impress, but demand from the data center market drove a double-digit increase in both revenue and earnings. Broadcom expects that solid growth to continue in the fourth quarter, despite an expected decline in wireless revenue.

Broadcom results: The raw numbers

Metric

Q3 2018

Q3 2017

Year-Over-Year Change

Revenue

$5.06 billion

$4.46 billion

13.5%

Net income attributable to common stock

$1.20 billion

$481 million

149%

Non-GAAP earnings per share

$4.98

$4.10

21.5%

Data source: Broadcom.

What happened with Broadcom this quarter?

  • More than 50% of the company's revenue base was exposed to strong data center demand during the quarter.
  • The wired infrastructure segment produced revenue of $2.30 billion, up 4% year over year.
  • The wireless communications segment produced revenue of $1.29 billion, unchanged from the prior-year period.
  • The enterprise storage segment produced revenue of $1.25 billion, up 70% year over year.
  • The industrial and other segment produced revenue of $225 million, down 5% year over year.
  • GAAP gross margin was 51.7%, up from 48.2% in the prior-year period. Non-GAAP gross margin was 67.3%, up from 63.3% in the year-ago period.
  • Cash from operations was $2.25 billion, up from $1.66 billion in the third quarter of 2017. Free cash flow was $2.13 billion.
  • Broadcom repurchased 24 million shares during the third quarter, costing roughly $5.38 billion.
  • Broadcom announced the acquisition of mainframe software company CA Technologies on July 11. The enterprise value of the deal is approximately $18.4 billion. The transaction is expected to close in the fourth calendar quarter of 2018, funded by $18 billion of new debt.
  • Broadcom declared a quarterly dividend of $1.75 per share, payable on Sept. 28 to shareholders of record on Sept. 19.

Broadcom provided the following guidance for the fourth quarter of fiscal 2018:

  • Revenue of $5.397 billion, plus or minus $75 million, up from $4.84 billion in the fourth quarter of 2017.
  • Gross margin of 52.3%, plus or minus 1%, and non-GAAP gross margin of 67%, plus or minus 1%.
  • Guidance implies non-GAAP EPS of $5.59, up from $4.59 in the prior-year period.
Servers in a data center.

Image source: Getty Images.

What management had to say

CEO Hock Tan commented on the growth in the enterprise storage business during the earnings call: "This, of course, includes a contribution from Brocade but even without Brocade storage was robust year-on-year in the third quarter. Looking at the fourth quarter, strong demand from enterprise continues to be good and we expect year-on-year storage revenue growth to accelerate."

Broadcom closed its $5.5 billion acquisition of Brocade in November of last year, giving its data center-related business a boost.

Tan also discussed the wireless segment and its dependence on Apple's iPhones: "We benefited from the initial seasonal ramp at our North American OEM customer, which was partially offset by anticipated decline in our other large wireless customer. We expect this ramp in our North America OEM customer to drive wireless revenue to be over 25% sequentially even as it may be down single-digit year on year."

Tan also explained why Broadcom acquired CA Technologies:

CA sells mission-critical software to virtually all of the world's largest enterprises. These are global leaders in key verticals including financial services, telecoms, insurance, healthcare, and retail. And CA does it at a scale fairly unique to the infrastructures of web space. This can only come from long-standing relationships with these customers that span several decades. In other words, these guys are deeply embedded.

Looking forward

Even with the wireless segment treading water during the third quarter, strong growth in the portion of the business tied to the data center drove Broadcom's revenue and earnings higher. The expected launch of the next batch of iPhones is near. That will boost wireless revenue in the fourth quarter, but Broadcom is anticipating a year-over-year decline.

The acquisition of CA Technologies may seem out of place for a company that has been building a chip empire via acquisitions. Not only is CA Technologies a software company, but it derives most of its profits from mainframes. But the price was reasonable, and CA Technologies is deeply entrenched with its customers. While the deal will balloon Broadcom's debt load, it will also boost the bottom line.

Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends AAPL. The Motley Fool has the following options: long January 2020 $150 calls on AAPL and short January 2020 $155 calls on AAPL. The Motley Fool recommends Broadcom Ltd. The Motley Fool has a disclosure policy.