uploads/2016/09/Series-147-A7-1.png

How Broadcom Plans to Achieve Its Target Profit Margins

By

Updated

Broadcom’s profitability

So far, we’ve seen that Broadcom (AVGO) has witnessed strong demand from Apple (AAPL) and Samsung (SSNLF) and that things in the storage market have stabilized, driving the company’s revenue up in fiscal 3Q16. The same growth momentum is expected to continue in fiscal 4Q16.

Broadcom’s target is to sustain mid-single digit revenue growth percentage-wise at a gross margin of more than 60% and an operating margin of more than 40%. The company is on track to achieve its target financial model.

Article continues below advertisement

Gross margin

Broadcom’s non-GAAP (generally accepted accounting principles) gross margin rose from 60% in fiscal 2Q16 to 60.4% in fiscal 3Q16. However, its gross margin was lower than the 61.3% it reported in fiscal 3Q15. 

As seen in the above graph, the company’s gross margin fell post-merger as Broadcom brought high inventory along with it. Now, the company has offloaded its non-core products, reduced its inventory, and improved its operational efficiency.

The company is transitioning from 6-inch to 8-inch wafer technology, and so far, it’s transitioned close to 50% of its production to 8-inch wafers. It’s spending a large amount of capital to convert its entire production to 8 inches. This will reduce the cost of sales in the future, thus improving its gross margin.

Article continues below advertisement

Operating margin

Broadcom’s non-GAAP operating margin rose from 37.3% in fiscal 2Q16 to 39.3% in fiscal 3Q16. The company improved its margin sequentially, as it maintained its operating expenses at $808 million while its revenue rose by 7%.

The company’s operating expenses were sequentially flat as cost savings arising from the merger were offset by higher bonus accruals due to higher profitability. This trend is expected to continue in fiscal 4Q16.

However, the company’s 39.3% operating margin was lower than its 41.9% operating margin in fiscal 3Q15. While the company’s revenue growth and gross margins meet its target model expectations, its operating margin is falling short. The company aims to achieve a 40% operating margin in fiscal 4Q16, and it expects this margin to improve further in fiscal 2017.

The combined company is currently integrating Avago and SAP’s (SAP) Oracle (ORCL) ERP (enterprise resource planning) system and Broadcom’s ERP system into one. This integration would reduce the workforce requirement and improve operating cost structure. The benefits of this ERP integration would be visible in improved operating margins in fiscal 2017.

Next, we’ll look at the company’s earnings per share.

Advertisement

More From Market Realist