Taking a look at the numbers, AVGO posted EPS of $5.55, beating the Street by $0.32, with revenue up 8.6% to $5.79 bln, coming up short of the $5.83 bln consensus. The topline miss, though, is being largely dismissed because investors were already well-aware that the weakness in wireless would add pressure to demand this quarter.
On that note, Apple (AAPL) represents about a quarter of AVGO's total business. AAPL slashed its guidance back on Jan. 1, citing economic headwinds in China, leading to lower-than-expected iPhone sales. AAPL's guidance cut was followed up by chip giant Samsung (SSNLF) doing the same on Jan. 8. Main AVGO competitor, Skyworks (SWKS), issued downside guidance for the quarter ahead on Feb. 5. So, the weak results for AVGO's wireless segment of revenue being down 12% yr/yr was completely discounted heading into last night's report and essentially a non-factor.
A key to AVGO's impressive outperformance on earnings is that gross margin shot up to 55.4% from 49.3% in the year ago quarter. Much of the expansion is related to its July 11, 2018 acquisition of CA, a provider of information technology management software. The impetus for the acquisition was to transform its business from mainly a semiconductor device manufacturer, into a broad-based infrastructure technology provider focused on mission critical technology.
After AVGO acquired CA, it made a couple important changes to its business model. Namely, one new focus for CA is to renew contracts for mission critical software with existing mainframe-centric clients. Additionally, it is changing the contract model for core customers from a perpetual license agreement to an enterprise-wide license model. The CA integration is progressing well as the Infrastructure Software segment posted revenue of $1.4 bln, comfortably beating analysts' $1.2 bln expectation.
Furthermore, AVGO commented last night that it is on track to meet or exceed the longer-term targets it outlined for CA when it acquired the company - specifically, for CA business to generate $3.5 bln in sales in 2-3 years, while generating $2.5 bln in profits for an operating margin of 71%. The CA integration drove most of the gross margin improvement, but, management also said that the semiconductor business experienced improvement as well due to favorable mix.
The other main takeaway from the report and earnings call is that AVGO expressed a lot of optimism regarding the wireless division in the back half of 2019, which led to it reaffirming its FY19 guidance. Similar to its competitors, it agreed that the slowdown in China is hurting demand. However, it noted that most of this weakness was baked into its guidance already, enabling it to reaffirm.
Like peer SWKS, it sees wireless chips bottoming out this quarter, with "meaningful growth" resuming in 2H19, due to strong product cycles in its wireless and networking chip business, along with a recovery for its broadband business. Of course, a significant catalyst for AVGO will be new iPhone launches, expected in the Sept/Oct time-frame. Beyond that, AAPL is expected to launch its first 5G iPhone in 2020 which should translate to another major catalyst for the company late in 2020.
A couple other standout metrics: AVGO generated $2 bln in free cash flow in the quarter, up 39% yr/yr, and cash flow from operations was $2.1 bln. The healthy cash flow allowed AVGO to buyback $3.5 bln in stock, which also played a role in the better-than-expected earnings performance.