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Micron beat and raised in Q3 as strong high-bandwidth memory (HBM) demand and price increases drove revenue growth of 81.5% in the quarter. Management reiterated their forecast for several hundred million in HBM revenue in fiscal 2024, with Q3 generating north of $100 million in HBM revenue in the quarter. Micron also offered its first look at fiscal 2025 for HBM, seeing “multiple billions” of HBM revenue next fiscal year, implying growth may come in more than ten-fold next year for this portion of its DRAM business.
CEO Sanjay Mehrotra said that Micron is “gaining share in high-margin products like High Bandwidth Memory, and our data center SSD revenue hit a record high.” He added that Micron is “excited about the expanding AI-driven opportunities ahead, and are well positioned to deliver a substantial revenue record in fiscal 2025.”
Micron also mentioned that HBM is sold out for calendar 2025 with pricing already contracted for. There are some drawbacks to this as the market may interpret it as a lack of potential for upside. That is being too hasty as the exact pricing is not disclosed, only that HBM is sold out. This will probably be the situation into the foreseeable future due to low yields from HBM.
Revenue and EPS
Micron’s revenue growth accelerated sharply in Q3, with the company reporting revenue growth of 81.5% YoY, a 2380 bp acceleration from 57.7% YoY growth last quarter. Micron’s Q4 guide was barely above the consensus estimate although revenue growth is still accelerating, with the midpoint of the guided range pointing to 89.5% YoY growth next quarter.
Q3 revenue was $6.81 billion, an increase of 81.5% YoY and 16.9% QoQ.
Fiscal Q4 revenue was guided at $7.6 billion, +/- $200 million, for YoY growth of 89.5% and QoQ growth of 11.6%. This marginally beat the consensus estimate of $7.58 billion, but fell short of Citi’s expectation for an $8 billion revenue guide.
Q3 GAAP EPS was $0.30, in line with estimates. This was a strong increase from ($1.73) in the year ago quarter, but a sequential decline from $0.71 last quarter. The sequential decline was due to a ($377 million) income tax provision in Q3, whereas Q2 benefitted from a $622 million income tax benefit.
Q3 adjusted EPS was $0.62, beating estimates for $0.53. This compares to adjusted EPS of ($1.43) in the year ago quarter and $0.42 last quarter.
For Q4, Micron guided GAAP EPS to be $0.61, +/- $0.08 for QoQ growth of 103%, at the midpoint. Adjusted EPS was guided at $1.08, +/- $0.08, for QoQ growth of 74% at midpoint.
Margins
Micron’s Q3 report was a standout on margins, as increased prices drove significant expansion in Q3’s margins down the line and pointed to margin expansion continuing next quarter. Q4’s gross margin guide and implied operating margin levels were very strong.
Management stated the following in terms of how to model a higher product mix of HBM: “Keep in mind that higher mix of HBM will offset non-HBM DRAM cost reductions, but HBM will be at accretive gross margins.” In the long run, “portfolio mix will be an important contributor over time as HBM, high-capacity DIMMs, data center SSDs and other high-value products increase as a portion of our mix.”
Q3’s margins were strong across the board, coming in ahead of management’s guided ranges and reflecting strong QoQ and YoY expansion.
GAAP gross margin was 26.9% in Q3, an 840 bp QoQ and 4470 bp YoY expansion up from from (-17.8%). This came ahead of management’s guide for 25.5%.
Adjusted gross margin was 28.1%, an 810 bp QoQ and 4420 bp YoY expansion.
GAAP operating margin was 10.6%, a 730 bp QoQ and 5750 bp YoY expansion up from (-46.90). This also was ahead of management’s implied guide for 8.7%.
Adjusted operating margin was 13.8%, a 1030 bp QoQ and 5300 bp YoY expansion.
GAAP net margin was 4.9%, down from 13.6% last quarter but up substantially from (50.5%) in the year ago quarter. The QoQ decline was due to the income tax provision.
Adjusted net margin was 10.3%, up from 8.2% last quarter and (41.7%) in the year ago quarter.
Q4’s guided margins point to continued expansion, with the impacts of this margin strength increasingly evident when viewed in dollar terms.
For Q4, management guided GAAP gross margin at 33.5%, +/- 1.0%, representing a 660 bp QoQ and 4430 bp YoY expansion (on pace with Q3’s YoY expansion). Last year, GAAP gross margin was (-10.80%).
Q4’s adjusted gross margin was guided at 34.5%, up 640 bp QoQ and 4360 bp YoY.
For Q4, based on management’s operating expenditure guides, GAAP operating margin is expected to be 17.8%, up 720 bp QoQ and 5450 bp YoY. Last year, GAAP operating margin was (-36.70%).
Adjusted operating margin is expected to be 20.6%, up 680 bp QoQ and 5070 bp YoY, and reaching the highest level since Q4 2022.
Here’s what the expansion in margins looks like in dollar terms:
Gross profits of $1.8 billion reported in Q3 will increase to $2.5 billion in Q4. This is following a loss of $668 million last year.
Operating income of $700 million in Q3 will grow to $1.3 billion in Q4. This is following a loss of $1.7 billion in Q3 of last year.
Cash and Debt
Cash flows were particularly strong as well, with operating cash flow more than doubling QoQ and free cash flow returning to positive territory.
Operating cash flow was $2.48 billion in Q4, more than double the $1.22 billion generated last quarter and a significant improvement from $24 million in the year ago quarter. OCF margin was 36.4%, compared to 20.9% last quarter and 0.6% in the year ago quarter.
Adjusted free cash flow was $425 million, compared to ($29 million) last quarter and ($1.36 billion) in the year ago quarter. Adjusted FCF margin was 6.2%, versus (0.5%) last quarter and (36.1%) in the year ago quarter.
Cash, investments and restricted cash totaled $9.22 billion, and debt totaled $13.26 billion.
Key Segments
DRAM revenue increased 13% QoQ to $4.7 billion, with the sequential growth decelerating from 21% in Q2 and 24% in Q1. DRAM ASPs increased approx. 20% QoQ, accelerating from the high-teens last quarter.
NAND revenue increased 32% QoQ to $2.1 billion, accelerating from 27% QoQ growth in Q2. NAND ASPs increased approx. 20% QoQ.
The following guidance was provided: “We expect DRAM bit shipments to be flattish and NAND shipments to be up slightly in fiscal Q4. We forecast shipment growth to strengthen modestly in the November quarter.” The market may have wanted more in terms of sequential growth given the strong QoQ growth seen in the prior two quarters.
Compute and Networking (CNBU) revenue increased 18% QoQ and 85% YoY to $2.57 billion.
Mobile (MBU) revenue decreased (1%) QoQ but increased 94% YoY to $1.59 billion.
Embedded (EBU) revenue increased 16% QoQ and 42% YoY to $1.29 billion.
Storage (SBU) revenue increased 50% QoQ and 116% YoY to $1.35 billion.
Management said that in the data center, “rapidly growing AI demand enabled us to grow our revenue by over 50% on a sequential basis, and we grew share in high margin AI-related product categories such as HBM, high-capacity DIMMs and data center SSDs.”
HBM Growth Strong, 2025 Outlook Sees Multiple Billions in Revenue
We had noted in our pre-earnings write-up that Micron’s updates on HBM3e were to be closely watched, and management finally unveiled its FY25 HBM revenue targets as well as HBM3e revenue for Q3.
Management had said last quarter that Micron was “on track to generate several hundred million dollars of revenue from HBM in fiscal 2024,” and left that target unchanged. However, management clarified that the “HBM shipment ramp began in FQ3, and we generated over $100M in HBM3E revenue in the quarter, at margins accretive to DRAM and overall company margins.” Micron has also “sampled our 12-high HBM3E product and expect to ramp it into high volume production in CY25, and increase in mix throughout 2025.”
In addition, management now sees “multiple billions in revenue from HBM in FY25,” this will be up from several hundred million in FY24.
Notably, demand on HBM will outstrip supply for some time due to HBM consuming 3X more wafers than D5. The trade ratio will increase from HBM3 to HBM4, as increasing the die stack from 8 to 12 will exacerbate the issue of low HBM yields. The yields will be far less than the previous generation of DRAM, creating more supply pressure.
We’ve mentioned before, but doesn’t hurt repeating, that Micron expects to have a similar market share in HBM by 2025 as it has in overall DRAM – which translates to 38% market share.
HBM Sold Out; Pricing Already Contracted
The blemish in the report is the commentary that HBM is sold out for calendar 2024 and 2025, with “pricing already contracted for the overwhelming majority of our 2025 supply.”
While contracts on pricing protect Micron in the event that prices fall, we’ve seen prices rise so far through 2024 on a tight-supply environment, suggesting that Micron may be expecting the supply side to ease and pricing increases to fade through 2025. Should prices continue to rise through 2025, having a majority of supply contracted already may limit some incremental revenue and margin growth. This could imply there is no further upward surprises due to tight supply and higher ASPs.
There was a question about this issue from the call.
Christopher Danely (Analyst)
“So I think you mentioned you're signing up some customers to long-term contracts. Given your belief that the pricing is going to keep going up, why sign people up to long-term contracts and potentially miss out on some of the increased pricing? Or is there some potential for wiggle room on pricing with the contracts and it's more of a unit basis? Just curious there.”
Sanjay Mehrotra (Executives)
“The long-term contracts really help us and customers get closer, not only with respect to, let's say, supply or pricing discussions as may be relevant to our various customer contracts, but also with respect to the technology road map, the product road map, the timing of the supply. And they are very helpful factors in building a close relationship with the customers. And you can see that we are pointing to a substantial revenue record in 2025, of course, leveraging some of these contracts that we have put in place, and we have also pointed to a significant improvement in profitability. So I think we are well positioned in these contracts with respect to not only the supply and demand fundamentals, but also with respect to the financial aspects.”
What’s important to note is that even if management knows what fiscal year 2025 will see from HBM pricing, they have not guided yet for FY2025. In addition to this, although data center is the main story for now, Micron’s revenue is also determined by the timing of AI PCs and Mobile.
Capex To Rise Meaningfully in FY25
Amidst the strong growth forecast for HBM next year, Micron also unveiled its FY25 capex plan, which calls for meaningful YoY growth in capex from its $8 billion target in FY24.
Management is planning for FY25’s capex to be in the “mid-30s % range of revenue” to support HBM assembly and test equipment, fab and back -end facility construction as well as technology transition investment to support demand growth.”
Management add that FY25’s “record revenue and significantly improved profitability in FY25 will help support average quarterly capex in FY25 to be meaningfully above the FQ4 2024 level of $3B.”
Given that current analyst estimates call for ~$37 billion in revenue in FY25, management is implying FY25 capex to increase by more than 50% YoY to over $12 billion, with the $14 billion range (a ~75% YoY increase) more likely given the quarterly average comment. This supports stronger price action in companies like Lam Research, which supplies Micron.
The CHIPS Act helps to offset this increase in capex. During the past quarter, Micron signed a preliminary memorandum to receive $6.1 billion in grants.
Here is what the CFO stated on the call and how it’s expected that revenue growth outpaces capex spending growth.
“Toshiya Hari (Analyst)
Okay. Got it. That's helpful. And then as my follow-up, maybe one for Mark on CapEx. So you're guiding fiscal year '25 up materially. Given some of the hints that you've provided, maybe you're looking at a mid-teens $1 billion number for fiscal '25. I know more than half of that or half of that is coming from the greenfield investments in the U.S. But how should we be thinking about your bit supply growth in fiscal '25 or calendar '25? Should we expect you guys to grow more or less in line with the demand CAGR you have for DRAM and NAND, mid-teens and high teens respectively? Or do you expect to undership relative to those ranges in fiscal '25?
Answer Mark Murphy (Executives)
Yes, we — good questions, Toshiya. And your view on CapEx, we've given enough that — we don't want to guide revenue for '25 because we'll do that at a future date by quarter. But we do expect a material increase year-over-year. For the quarter sequentially, we'll see a meaningful step up. And we were — we're at $3 billion — we increased from $2.1 billion to $3 billion third quarter to fourth quarter guide. I would characterize that both on a dollar and percent basis is more than meaningful. So it would be less than that sequentially. But we are spending more.
To your question on, we are very constrained on bits. — bit production. And so we will — as I mentioned in my earlier comments, we will certainly see inventory levels come down. In fact, we expect to be approaching target inventory levels by the end of 2025.
Note on HBM and NAND CAGRs
HBM’s CAGR is expected to remain strong and be above 50% for the next few years.
“Well, as we have said before, that we see the CAGR for HBM growth — in terms of bit growth CAGR to be well above 50% over the next few years. So certainly, HBM is a strong growth driver. And again, as we increase our mix of HBM going forward, it will, of course, be continuing to be accretive to our financial performance, including margins. And we are pleased that with the strong performance that we have we are sold out for '25 as well with overwhelming part of our output already committed in terms of pricing.”
During the Q&A, it was pointed out that the forecast for NAND CAGR growth was lowered from “the low 20s” to a new forecast of “growth in the high teens.” Management’s response was the following:
“And I'll also tell you that we basically revise the base here for the CAGR that we used. So this time, the CAGR that we used, we use the base year of 2023. And in 2023, as you know, we had bit demand growth in NAND that was higher, meaningfully higher than the CAGR. So that, of course, the larger base of 2023, just somewhat changed our outlook on the overall CAGR.”
This is important to note should we see headlines tomorrow that NAND growth will be lower than expected, that it’s instead a different baseline year.
Comments on AI PCs & Mobile
Per management, AI PCs are expected to accelerate in Q4 and throughout 2025 due to the Windows 12 replacement cycle. Micron will benefit as management explained: “we expect these devices will have 40% to 80% more DRAM content than today’s average PC.”
Micron’s management sees smartphones growing in the “low-to-mid single-digit percentage range.” Micron’s DRAM is seeing a 50% to 100% increase in Tier 1 Android phones from the mid-range Android phone having 6GB or 8GB to AI-enabled smartphones requiring 12GB and 16GB. Per the opening remarks: “In calendar Q1, we received recognition for being #1 in quality by five of the world’s leading smartphone OEMs.”
Conclusion:
There was a quote from management in the opening remarks that checks a lot of boxes.
“As we look ahead to 2025, demand for AI PCs and AI smartphones and continued growth of AI in the data center create a favorable setup that gives us confidence that we can deliver a substantial revenue record in fiscal 2025, with significantly improved profitability underpinned by our ongoing portfolio shift to higher-margin products.”
You can’t complain about “a substantial revenue record” on the horizon plus improved profitability and a mix of higher-margin products. It would be hasty to assume the 2025contracted pricing can’t deliver a beat or upward surprise, which grew 20% QoQ, and rather, we will want to watch DRAM QoQ growth more closely as it’s decelerated from the 20% QoQ range, down to 13% and now down to flat QoQ growth expected for next quarter.
With Micron at 73% YTD compared to QQQ at 20% YTD, the stock certainly has performed well. There are many paths for Micron to continue to perform well that we will be monitoring closely.
Damien Robbins and Beth Kindig contributed to this analysis
Micron will release its results on June 26th. The company reported a 42% acceleration to 57.7% revenue growth in the last quarter. Management expects revenue to accelerate 18.2% to 75.9% growth in Q3 FY2024.
The strength of the bottom line was the outlier in the report. The company achieved its goal of a positive adjusted operating margin a quarter ahead of expectation, primarily helped by the recovery in the DRAM and NAND pricing. Management is confident this trend will continue and expects positive free cash flow in the second half of the year and record revenue in FY2025.
The company is riding the Artificial Intelligence wave. Its HBM (High-Bandwidth Memory) is sold out for the calendar year 2024 and most of 2025 supply is being allocated. As a result of strong AI demand, the prices of HBM are expected to increase, which should help to drive higher revenues and profitability.
Revenue
The analysts expect revenue to grow 77.8% YoY to $6.67 billion and accelerate to 88.4% in Q4 FY2024. It is slightly higher than the management guide of 75.9% for Q3 FY2024. The company’s Q2 FY2024 revenue grew by 57.7% YoY to $5.82 billion, a 42% acceleration from Q1.
Q2 DRAM revenue grew by 21% sequentially to $4.2 billion, primarily helped by the increase in bit shipments in the low-single-digit percentage and price increasing by high teens. DRAM accounted for 71% of Q2 revenue.
Q2 NAND revenue grew by 27% sequentially to $1.6 billion, primarily helped by the increase in price of over 30% and offset by the decrease in bit shipments. NAND accounted for 27% of Q2 revenue.
The company provided an update during the J.P. Morgan conference on the company’s efficient handling of the disruption caused by the Taiwan earthquake. “We did have — and we put out the statement that up to about mid-single-digit percent of 1 quarter's DRAM output loss through a combination of some wafers that had to be scrapped, some lost production as we were restarting equipment, and then some slightly lower yields on product that was already in process. But all in all, I think the Micron teams responded extremely well. And as you note, we haven't had to make any further comments since then. And as Mark noted, no further comments relative to our guidance either.”
Margins
Margins have experienced a steep cyclical low and now appear to have bottomed out. The company achieved its goal of positive adjusted operating margin a quarter ahead of expectation, primarily helped by the recovery in the DRAM and NAND pricing.
Other factors include lower utilization charges, which management expects to be lower in the future. CFO Mark Murphy replied to an analyst question on the margins in the earnings call, “On the underutilization charges, Chris, they went from, I think it was $165 million in the first quarter down to under $50 million in the second quarter. We believe they'll stay at low levels well below 50 for the foreseeable future. So we'll no longer comment on those.”
Gross margin improved by 51.2 percentage points YoY and by 19.2 points sequentially to 18.5%. It was primarily helped by higher prices, selling the remainder of written-down inventories, and lower utilization charges. The management guide for the next quarter is 25.5%. Similarly, the adjusted gross margin improved 51.4 points YoY to 20%. The management guide for the next quarter is 26.5% and sequential improvement is helped by “robust price increases across both DRAM and NAND.”
Operating margin improved 65.7 percentage points YoY and up 27.2 points sequentially to 3.3%. The management guide for the next quarter is 8.7%. The adjusted operating margin improved 59.7 percentage points YoY and up 23.7 points sequentially to 3.5%, primarily helped by the factors discussed above and partly offset by higher variable compensation expense due to the improved 2024 outlook. Management adjusted operating margin guide for the next quarter is 11.5% after accounting for a $30 million sequential increase in operating expenses due to increased R&D expenses.
Net income was $793 million or 13.6% of revenue compared to a net loss of (-$2.3 billion) or (-62.6%) of revenue. The adjusted net income was $476 million or 8.2% of revenue compared to a net loss of (-$2.081 billion) or (-56.3%) of revenue. GAAP EPS came at $0.71 and beat estimates by 285.4% and adjusted EPS came at $0.42 and beat estimates by 273.7%.
The management GAAP EPS guide is $0.17 +/- $0.07 and adjusted EPS guide is $0.45 +/- $0.07 for Q3. The analysts expect the company to report adjusted EPS of $0.52.
Management made it crystal clear that HBM is accretive to margins and the strength in margin is due to pricing power. “So with respect to the accretive nature of HBM, look, HBM carries a higher cost, but it also carries a significantly higher pricing because it brings such great value in the applications in terms of its performance and power. And we are executing well. Our yield ramp is going well as well according to plan.”accretive nature of HBM, look, HBM carries a higher cost, but it also carries a significantly higher pricing because it brings such great value in the applications in terms of its performance and power. And we are executing well. Our yield ramp is going well as well according to plan.”
“And therefore, we are pleased that in this quarter, when we have begun our production shipments, we will be having it accretive to our gross margins in the quarter. And of course, this momentum will continue to build in the quarters ahead.”we will be having it accretive to our gross margins in the quarter. And of course, this momentum will continue to build in the quarters ahead.”
Cash and Balance Sheet
Q2 FY2024 operating cash flow was $1.22 billion or 20.9% of revenue compared to $343 million or 9.3% of revenue in the same period last year. Adjusted free cash outflow was (-$29 million) or (-0.50%) of revenue compared to adjusted free cash outflow of (-$1.81 billion) in the same period last year.
Due to the increase in investments in AI chips, the company slightly raised the capex last month by removing the lower range of the capex outlook for FY2024 of $7.5 billion to $8 billion to the current $8 billion. Management has reiterated positive free cash flow in the next two quarters.
The company had cash and investments of $9.7 billion and debt of $13.7 billion compared to $9.8 billion and $13.5 billion in the November quarter. In FQ2, the company refinanced $1 billion in debt, thereby extending the maturity and lowering the near-term borrowing costs. The company paid $127 million in dividends.
Key Metrics from Business Units
Compute and Networking Business Unit (CNBU) revenue showed a solid acceleration to 59% YoY and 26% QoQ growth to $2.185 billion from a decline of (-1%) YoY in the previous quarter. It was led by strong growth in data center revenue and cloud doubled sequentially.
Mobile Business Unit (MBU) revenue grew by 69% YoY and 24% sequentially to $1.598 billion. It was primarily helped by the increase in price and offset by the decrease in volume.
Embedded Business Unit (EBU) revenue grew by 28% YoY and 7% sequentially to $1.11 billion, it was led by strong demand for leading-edge products in the industrial market.
Storage Business Unit (SBU) revenue grew by 79% YoY and up 39% sequentially to $905 million. The company reported a strong acceleration from a (-4%) decline in the previous quarter. The company witnessed strong growth in all the end markets and Datacenter SSD revenue doubled on a YoY basis, driven by share gains for the company’s products.
Other noteworthy points to watch
HBM3e
Management updates on the HBM3e are to be closely watched. In December, Micron’s HBM3e was a core part of our multi-faceted AI-driven growth thesis. The company provided positive updates on HBM3e development and revenue generation in the last earnings call.
CEO Sanjay Mehrotra said “We commenced volume production and recognized our first revenue from HBM3E in fiscal Q2 and now have begun high-volume shipments of our HBM3E product.” The company is “on track to generate several hundred million dollars of revenue from HBM in fiscal 2024.”
Micron expects these HBM revenues “to be accretive to our DRAM and overall gross margins starting in the fiscal third quarter.” This is an important quote – Micron has already driven tremendous improvement in gross and operating margins in Q2, and the HBM pricing power will further provide a tailwind to margins going forward. Moving beyond fiscal Q3 and Q4 and into fiscal 2025, margins are expected to continue to expand at a fairly strong rate as HBM revenues ramp up significantly.
Micron shed light on customers and capacity, noting that while its HBM3e will be a part of Nvidia’s H200 Tensor Core GPU, it is “making progress on additional platform qualifications with multiple customers.”
Recently, Samsung failed Nvidia’s tests due to the heat and power consumption issues. Wells Fargo said that the Micron is likely to benefit from the Samsung HBM issues.
Micron’s upcoming 12-high HBM3e has been sampling to customers, and Micron said it will begin ramping the cube in high volume production throughout 2025: “Earlier this month, we sampled our 12-high HBM3E product, which provides 50% increased capacity of DRAM per cube to 36 gigabytes. This increase in capacity allows our customers to pack more memory per GPU, enabling more powerful AI training and inference solutions. We expect 12-high HBM3E will start ramping in high-volume production and increase in mix throughout 2025.”We expect 12-high HBM3E will start ramping in high-volume production and increase in mix throughout 2025.”
Nvidia’s H200 win is a major win for Micron, as competition in the HBM landscape remains stiff. Per management: “NVIDIA announced its next-generation Blackwell GPU architecture-based AI systems, which provides a 33% increase in HBM3E content, continuing a trend of steadily increasing HBM content per GPU. Micron's industry-leading high-bandwidth memory HBM3E solution provides more than 20x the memory bandwidth compared to standard D5-based DIMM-server module.”which provides a 33% increase in HBM3E content, continuing a trend of steadily increasing HBM content per GPU. Micron's industry-leading high-bandwidth memory HBM3E solution provides more than 20x the memory bandwidth compared to standard D5-based DIMM-server module.”
Edge AI – Smartphone and PCs
Smartphone recovery is another tailwind for the company. Also, AI smartphones have a substantial increase in DRAM content compared to non-AI phones. The company’s DRAM and NAND solutions are already included in leading smartphones like Samsung Galaxy S24 and Honor Magic 6 Pro.
“Smartphone unit volumes in calendar 2024 remain on track to grow low to mid-single digits. Smartphones offer tremendous potential for personalized AI capabilities that offer greater security and responsiveness when executed on device. Enabling these on-device AI capabilities is driving increased memory and storage capacity needs and increasing demand for new value-add solutions. For example, we expect AI phones to carry 50% to 100% greater DRAM content compared to non-AI flagship phones today.we expect AI phones to carry 50% to 100% greater DRAM content compared to non-AI flagship phones today.
Micron's leading mobile solutions provide the critical high performance and power efficiency needed to unlock an unprecedented level of AI capability. In DRAM, we are now sampling our second-generation, 1-beta LPDRAM LP5X product, which delivers the industry's highest performance at improved power for flagship smartphones.”which delivers the industry's highest performance at improved power for flagship smartphones.”
PCs are expected to be another growth market for Micron. Management expects PCs to return to growth in CY2024 in the “low single-digit range.” The neural processing units (NPU) chipsets that AI PCs require will see 40% to 80% more DRAM content than non-AI PCs.
Valuation
The company trades at a P/S ratio of 8.4 and a forward P/S ratio of 6.2. The stock is trading significantly higher than the 5-year P/S ratio of 3.4 as the company is one of the key beneficiaries of the AI trend.
Conclusion
We entered a position with Micron in December last year for a thesis we have carefully built on a memory rebound. Micron’s HBM3e was a core part of our multifaceted AI-driven growth. We further believe we should have a long run away with Edge AI to be the next growth driver, potentially in 2025.
This article was originally published on Forbes on Jun 20, 2024,04:13pm EDTForbesForbes on Jun 20, 2024,04:13pm EDT
Big Tech is spending tens of billions quarterly on AI accelerators, which has led to an exponential increase in power consumption. Over the past few months, multiple forecasts and data points reveal soaring data center electricity demand, and surging power consumption. The rise of generative AI and surging GPU shipments is causing data centers to scale from tens of thousands to 100,000-plus accelerators, shifting the emphasis to power as a mission-critical problem to solve.
Increasing Power Consumption Per Chip
As Nvidia, AMD, and soon Intel begin to roll out their next generation of AI accelerators, the focus is now shifting towards power consumption per chip, whereas the focus has been primarily on compute and memory. As each new generation boosts computing performance, it also consumes more power than its predecessor, meaning that as shipment volumes rise, so does total power demand.
Nvidia’s A100 max power consumption is 250W with PCIe and 400W with SXM (Server PCIe Express Module), and the H100’s power consumption is up to 75% higher versus the A100. With PCIe, the H100 consumes 300-350W, and with SXM, up to 700W. The 75% increase in GPU power consumption happened rapidly, within two brief years, across one generation of GPUs.
When we look at other GPUs on the market today, AMD’s MI250 accelerators draw 500W of power, up to 560W at peak, while the MI300x consumes 750W at peak, up to a 50% increase. Intel’s Gaudi 2 accelerator consumes 600W, and its successor, the Gaudi 3, consumes 900W, again another 50% increase over the previous generation. Intel’s upcoming hybrid AI processor, codenamed Falcon Shores, is expected to consume a whopping 1,500W of power per chip, the highest on the market.
Nvidia’s upcoming Blackwell generation boosts power consumption even further, with the B200 consuming up to 1,200W, and the GB200 (which combines two B200 GPUs and one Grace CPU) expected to consume 2,700W. This represents up to a 300% increase in power consumption across one generation of GPUs with AI systems increasing power consumption at a higher rate. SXM allows the GPUs to operate beyond the PCIe bus restrictions, offer higher memory bandwidth, high data throughput and higher speeds for maximal HPC and AI performance, thus drawing more power.
It’s important to note that each subsequent generation is likely to be more power-efficient than the last generation, such as the H100 reportedly boasting 3x better performance-per-watt than the A100, meaning it can deliver more TFLOPS per watt and complete more work for the same power consumption. However, GPUs are becoming more powerful in order to support trillion-plus large language models. The result is that AI requires more power consumption with each future generation of AI acceleration.
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Big Tech’s AI Ambitions Lead to Surging GPU Shipments
From Big Tech’s perspective, we’re still in the early stages of this AI capex cycle. Most recently, we covered how Big Tech is boosting capex by more than 35% YoY in 2024, likely upwards of $200 billion to $210 billion, predominantly for AI infrastructure. The majority is flowing to GPU purchases and custom silicon, to power AI training, model development, and to meet elevated demand in the cloud.
2023 was a breakout year for Nvidia’s data center GPUs, with reports placing annual shipments at 3.76 million, for an increase of more than 1.1 million units YoY. A report stated that at peak of 700W and ~61% annual utilization, each GPU would draw 3.74 MWh; this means that Nvidia’s 3.76 million GPU shipments could consume as much 14,384 GWh (14.38 TWh). A separate report estimated that with 3.5 million H100 shipments through 2023 and 2024, that H100 alone could see total power consumption of 13.1 TWh annually.
The 14.4 TWh is equivalent to the annual power needs of more than 1.3 million households in the US. This also does not include AMD, Intel, or any of Big Tech’s custom silicon, nor does it take into account existing GPUs deployed or upcoming Blackwell shipments in 2024 and 2025. As such, the total energy consumption is likely to be far higher by the end of the year as Nvidia’s Blackwell generation comes online in larger quantities.
To read more about Nvidia’s upcoming Blackwell architecture, reference our previous analysis: Nvidia Q1 Earnings Preview: Blackwell and the $200B Data Center.Nvidia Q1 Earnings Preview: Blackwell and the $200B Data Center. If you own AI stocks, or are looking to own AI stocks and want to learn more, we encourage you to attend our upcoming weekly webinar, held this Thursday at 4:30 pm EST. Learn more here.here.
A Path to Million GPU Scale
Nvidia and other industry executives have laid out a path for GPU clusters in data centers to scale from the tens of thousands of GPUs per cluster to the hundred-thousand-plus range, even up to the millions of GPUs by 2027 and beyond. We’re already seeing signs of strong demand for Nvidia’s Blackwell platform, but overall, the million-plus GPU data center target is still years away.
Oracle’s Chairman Larry Ellison sees this creating secular tailwinds for data center construction, due to both rising GPU demand and increased power requirements driving a shift to liquid cooling:
“This AI race is going to go on for a long time. It's not a matter of getting ahead, just simply getting ahead in AI, but you also have to keep your model current. And that's going to take larger and larger data centers. … The data centers we are building include the power plants and the transmission of the power directly into the data center and liquid cooling. And because these modern data centers are moving from air cooled to liquid cooled, and you have to engineer them from scratch. And that's what we've been doing for some time. And that's what we'll continue to do.”
As the industry progresses towards that million-GPU scale, this puts more emphasis on future generations of AI accelerators to focus on power consumption and efficiency while delivering increasing levels of compute. Data centers are expected to adopt liquid cooling technologies to meet the cooling requirements to house these increasingly large GPU clusters.
As a result of booming demand for generative AI and for GPUs, AI’s electricity demand is forecast to surge, especially in the data center. We have a handful of different viewpoints and analyst projections that, while differing slightly in the timelines, all point to that same conclusion.
For example, Morgan Stanley is estimating global data center power use will triple this year, from ~15 TWh in 2023 to ~46 TWh in 2024. This coincides with the ramp of Nvidia’s Blackwell chip later in the year as well as utilization of the entirety of its deployed Hopper GPUs, and increased shipments from AMD and custom silicon ramps from Big Tech.
Morgan Stanley also projects generative AI power demand may exceed 2022’s data center power usage by 2027 if GPU utilization rates are high, at ~90% on average; however, their base case still calls for a nearly 5x increase in power demand over the next three years.
Morgan Stanley calls for a nearly 5x increase in generative AI power demand over the next three years in their base case scenario. Source: I/O Fund
Wells Fargo is projecting AI power demand to surge 550% by 2026, from 8 TWh in 2024 to 52 TWh, before rising another 1,150% to 652 TWh by 2030. This is a remarkable 8,050% growth from their 2024 projected level. AI training is expected to drive the bulk of this demand, at 40 TWh in 2026 and 402 TWh by 2030, with inference’s power demand accelerating at the end of the decade. In this model, the 652 TWh projection is more than 16% of the current total electricity demand in the US.
Source: I/O Fund
The Electric Power Research Institute forecasts that data centers may see their electricity consumption more than double by 2030, reaching 9% of total electricity demand in the US. The IEA is projecting global electricity demand from AI, data centers and crypto to rise to 800 TWh in 2026 in its base case scenario, a nearly 75% increase from 460 TWh in 2022. The agency’s high case scenario calls for demand to more than double to 1,050 TWh.
Source: I/O Fund
Arm’s executives also see data center demand rising significantly: CEO Rene Haas said that without improvements in efficiency, "by the end of the decade, AI data centers could consume as much as 20% to 25% of U.S. power requirements. Today that’s probably 4% or less." CMO Ami Badani reiterated Haas’ view that that data centers could account for 25% of US power consumption by 2030 based on surging demand for AI chatbots and AI training.
How the Supply Chain is Addressing Power Requirements:
Taiwan Semiconductor is an example of a supply chain company that plays a crucial role here, as its most advanced nodes tout lower power consumption and increased performance, which is why AI accelerators will soon shift from primarily being produced on the 5nm node to the 3nm node and eventually 2nm.
“At the foundry level, the 3nm process offers 15% better performance than the 5nm process when power level and transistors are equal. TSMC also states the 3nm process can lower power consumption by as much as 30%. The die sizes are also an estimated 42% smaller than the 5nm. …the 3nm process offers 15% better performance than the 5nm process when power level and transistors are equal. TSMC also states the 3nm process can lower power consumption by as much as 30%.also states the 3nm process can lower power consumption by as much as 30%. The die sizes are also an estimated 42% smaller than the 5nm. …
N3E is the baseline for IP design with 18% increased performance and 34% power reduction, N3P has higher performance and lower power consumption, whereas the N3X will offer high-performance computing with very high performance but with up to 250% power leakage.N3E is the baseline for IP design with 18% increased performance and 34% power reduction, N3P has higher performance and lower power consumption18% increased performance and 34% power reduction, N3P has higher performance and lower power consumption, whereas the N3X will offer high-performance computing with very high performance but with up to 250% power leakage.
The 2nm will be the first node to use gate-all-around field-effect transistors (GAAFETs), which will increase chip density. The GAA nanosheet transistors have channels surrounded by gates on all sides to reduce leakage, yet will also uniquely widen the channels to provide a performance boost. There will be another option to narrow the channels to optimize power cost. The goal is to increase the performance-per-watt to enable higher levels of output and efficiency. The N2 node is expected to be faster while requiring less power with an increase of performance by 10%-15% and lower power consumption of 25%-30%.”The goal is to increase the performance-per-watt to enable higher levels of output and efficiency. The N2 node is expected to be faster while requiring less power with an increase of performance by 10%-15% and lower power consumption of 25%-30%.”is expected to be faster while requiring less power with an increase of performance by 10%-15% and lower power consumption of 25%-30%.”
CEO C.C. Wei noted in Q1’s call that TSMC’s “customers are working with TSMC for the next node. Even for the next, next node, they have to move fast because, as I said, the power consumption has to be considered in the AI data center. So the energy-efficient is fairly important. So our 3-nanometer is much better than the 5-nanometer. And again, it will be improved in the 2-nanometer. So all I can say is all my customers are working on this kind of a trend from 4-nanometer to 3 to 2.”the power consumption has to be considered in the AI data center. So the energy-efficient is fairly important. So our 3-nanometer is much better than the 5-nanometer. And again, it will be improved in the 2-nanometer. So all I can say is all my customers are working on this kind of a trend from 4-nanometer to 3 to 2.”
The power problem is being addressed throughout the supply chain, from TSMC’s chip designs to renewable energy power agreements for Big Tech’s data centers. It’ll likely require the industry to move in tandem due to the sheer pace of GPU upgrades from Nvidia, soon AMD and possibly Intel.
We’re covering how another critical part of the supply chain is working to address power consumption this week for our premium members. Learn more here.here.
Conclusion
AI power demand is forecast to rise at a rapid rate. GPU demand is showing no signs of slowing as Big Tech continues to spend billions on AI infrastructure, with each GPU generation seeing higher peak power consumption. The industry is quickly taking steps to address this, and power consumption, or more specifically, power efficiency per chip, looks to be emerging as the third realm of competition.
We’ve covered the first two realms of competitions, raw computing power and memory, extensively in previous analysis, including “Here’s Why Nvidia will Reach $10 Trillion in Market Cap.” We think it’s important to keep a keen eye on this space as new winners will emerge as AI power consumption becomes mission critical.
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We recently covered Big Tech’s massive capex plans for 2024, with Microsoft, Meta, Amazon and Alphabet likely spending close to or upwards of $200 billion this year, and signaling a high likelihood of increasing capex in 2025. These spending plans are primarily for AI infrastructure, and while a majority of this spend is likely flowing to GPU leader Nvidia and then downstream to AI servers from Super Micro and Dell, the data center networking component shouldn’t be overlooked.
Arista Networks is a major supplier to Meta, and provided upbeat guidance this quarter. Lumentum, an optical and photonics components manufacturer did, as well, signaling an important opportunity for revenue growth from the data center. Management said they are “making excellent progress on the huge opportunities the long-term demand for data center photonics creates for us, driven by the exponentially increasing compute requirements of artificial intelligence, machine learning, and advanced data centers.”
Lumentum is in the high-risk bucket due to being a small cap, and because it requires speculation as to when a shift in fundamentals will occur. The stock will be reserved for the Advanced tier’s momentum portfolio for now, until we see more fundamental strength. This means technical analysis plays a primary role. We will close the position quickly (as soon as one day) if the setup fails. Or, we will hold for many months and increase its allocation if we see the stock shift to meet more of our criteria.
Background on Optical Interconnects
Optical interconnects help data centers accelerate data throughput between data centers, inside the data center between servers or racks, while reducing latency and power consumption. AI is driving cloud demand higher from the hyperscalers, leading to more data being created and processed, thus helping drive a need for these interconnects to meet demand for high-speed, low power data transmission in data centers.
It’s no secret that Big Tech is investing tens of billions in expanding and building physical data center infrastructure over the next five to ten years – just in May, AWS, Google and Microsoft announced tens of billions in investments to expand data center infrastructure globally, which we covered here. These continuous investments in physical infrastructure will not only require GPUs, but also other networking and optical components.
Lumentum’s management has been bullish on the data center optical component market for some time, saying in August 2023 that the “data center optical component market is projected to grow sharply over the next 4 to 5 years to accommodate the increased traffic associated with AI as customers employ ever higher bandwidth interconnects between racks within racks in between servers and storage. We also believe that Datacom VCSEL growth will be meaningful in the next several years as copper is replaced by short-reach multimode optical links.”
As a result, management is eyeing a rather quick ascent to $500 million in quarterly revenue by the end of next year, up 60% from Q4’s projected $302.5 million, while also expecting its cloud business to transform into a multi-billion dollar opportunity in the longer term.
Financials Suffering from Sharp Inventory Correction
Though Lumentum’s management expressed optimism on the longer-term potential of AI-driven data center revenue growth in its recent fiscal Q3 earnings call, the steep inventory correction in telecom has led to a substantial revenue decline and significant margin erosion, presenting a major fundamental headwind for data center growth to overcome.
Management noted in August 2023 that they were “facing significant headwinds as both our direct and end customers actively work to reduce their elevated inventory levels,” and estimated the correction to last through 2023 with shipments “well below end-market demand.” Lumentum reiterated in November 2023 that they were continuing to ship below end market demand.
This created a sharp revenue decline in barely a year and a half — from peak to trough (in six quarters from Q2 FY23 to Q4 FY24’s estimates), TTM revenue has fallen more than (26%).
Telecom Headwinds are Late to Clear
TTM (trailing twelve months) revenues peaked in fiscal Q2 2023 at $1.83 billion, and are now projected to sit at $1.35 billion based on Q4’s guidance. This telecom softness has continued to weigh on results with the inventory correction lasting longer than expected. Lumentum said in its Q3 earnings call in early May 2024 that “revenue will continue to be burdened by telecom customer inventory challenges. The pace of telco carrier spending has slowed more than previously anticipated. Because we continue to ship below end market demand, customer inventory of our products is decreasing, indicating that we are getting closer to the end of this lower demand phase in our industry.”
Once the inventory correction clears, revenue headwinds should subside, though there are lingering doubts about when exactly these issues will clear up, given that we’re now two quarters later than previously anticipated.
Fiscal Q3 Earnings Overview:
Turning to fiscal Q3, Lumentum reported revenue of $366.5 million, down (4.4%) YoY and flat QoQ. Management guided for $290 million to $315 million in fiscal Q4, representing a YoY decline of (18.4%) at the midpoint, far below the $331 million consensus estimate and suggesting its revenue recovery may not be out of the woods until after fiscal Q1 2025 (Sept 2024 quarter).
Margins have rapidly eroded, weighing on Lumentum’s bottom line. TTM gross margin was 20.4%, down from 36.4% a year ago and down from a peak of 46.0% in June 2022. Fiscal Q3’s gross margin of 16.2% suggests the decline in margins is not over yet.
Operating margin has fallen to (22.3%), down from 1.1% a year ago and 17.7% in the June 2022 quarter. Fiscal Q3’s operating margin was (31.3%), and Q4’s guided range points to operating margins declining again.
This is a pretty significant erosion in Lumentum’s operating margin that can’t be fixed solely via cost cuts; in order to drive operating margin to positive, revenue growth will need to rebound alongside improvements in gross margin, most likely back to 30% and higher.
Because of the revenue slump and margin weakness, Lumentum has burned through a substantial bit of cash, reporting $871 million in cash and equivalents in fiscal Q3, down from $1.67B a year ago and $1.22 billion last quarter. The QoQ decrease was primarily due to $323 million in debt repayment in Q3, as operating cash flow was only thinly negative, at ($7 million).
However, total long-term debt is $2.52 billion, raising the likelihood of a capital raise down the line to smooth out any issues with a shrinking cash balance while working to expand production capacity.
Management Quite Optimistic About Data Center Revenue Growth
Lumentum is quite optimistic about the data center opportunities that are arising from Big Tech spending tens of billions on data center infrastructure.
Nvidia’s earnings shed clarity on why Big Tech is investing in the data center at break-neck speeds: CEO Jensen Huang said that “Everybody is anxious to get their infrastructure online. And the reason for that is because they're saving money and making money, and they would like to do that as soon as possible.”
He further explained that Big Tech and other AI firms “need to make money today. They want to save money today. And time is really, really valuable to them. Let me give you an example of time being really valuable, why this idea of standing up a data center instantaneously is so valuable and getting this thing called time to train is so valuable. The reason for that is because the next company who reaches the next major plateau gets to announce a groundbreaking AI. And the second one after that gets to announce something that's 0.3% better. And so the question is, do you want to be repeatedly the company delivering groundbreaking AI or the company delivering 0.3% better? And that's the reason why this race, as in all technology races, the race is so important.”
Lumentum believes that this AI-fueled boom in physical data centers will help drive the next leg higher for its cloud segment. Management said in February 2024 that they expected “revenue from data center transceivers to temporarily dip in the June and September quarters, and then grow significantly through the end of the year and into calendar year '25,” as they work to build out leading-edge transceiver manufacturing capacity in Thailand.
This ties in to a more optimistic view on 2025, with management eyeing exiting the year at a $2B+ annualized revenue run rate, up from $1.35 billion based on Q4’s guidance. Here’s what management said:
“To summarize, the combination of explosive growth in cloud data center and AI-driven demand, our customer traction and capacity additions for new data center products and strong early demand for our new telecom products makes me confident and bullish about calendar 2025. We expect significant growth next calendar year as our investments in new data center products and manufacturing capacity this year translates into significant new revenues. This, combined with the telecom industry inventory correction abating, makes the outlook for calendar 2025 and beyond very promising. We have multiple cloud customer engagements which will drive meaningful revenue growth and drive total company quarterly revenue to exceed $500 million exiting calendar 2025. Additionally, we expect that significant growth will continue into 2026 and 2027. We are working on several significant opportunities today that we expect will propel our cloud business into a multi-billion dollar annual run rate business in the coming years.”We expect significant growth next calendar year as our investments in new data center products and manufacturing capacity this year translates into significant new revenues. This, combined with the telecom industry inventory correction abating, makes the outlook for calendar 2025 and beyond very promising. We have multiple cloud customer engagements which will drive meaningful revenue growth and drive total company quarterly revenue to exceed $500 million exiting calendar 2025. Additionally, we expect that significant growth will continue into 2026 and 2027. We are working on several significant opportunities today that we expect will propel our cloud business into a multi-billion dollar annual run rate business in the coming years.”
CEO Alan Lowe doubled down on this, saying “we would certainly be disappointed if we don't more than double our datacom business by then from today's or from the Q3 run rate.”we would certainly be disappointed if we don't more than double our datacom business by then from today's or from the Q3 run rate.”
Given the billions committed to data center infrastructure from Big Tech over the course of the next 3 to 5 years, there certainly is room for Lumentum to capture such growth, stemming from an increasing need to transmit data in and in between data centers. However, one risk arises here, in that Lumentum is walking a tightrope in working to simultaneously expand production capacity and meet demand without missing the mark.
Management said that “a lot of this incremental capacity is really new customers and diversified customers, both in the cloud space as well as the AI infrastructure space. And so, the challenge is it's a chicken and egg thing in that if you don't have the floor space and capacity, you're not going to get the orders. And … if you have the orders and you don't have the floor space, you're not going to be able to perform. So, we're working hand in hand with our customers to make sure that we're pulling the trigger at the right time to not have too much capacity, but at the same time to build confidence that we're making the investments on behalf of them and the growth that they see in calendar 2025 and beyond.”And so, the challenge is it's a chicken and egg thing in that if you don't have the floor space and capacity, you're not going to get the orders. And … if you have the orders and you don't have the floor space, you're not going to be able to perform. So, we're working hand in hand with our customers to make sure that we're pulling the trigger at the right time to not have too much capacity, but at the same time to build confidence that we're making the investments on behalf of them and the growth that they see in calendar 2025 and beyond.”
This is critical to note, not only because it is new customers and new capacity coming online, but also because it can be quite difficult to perfectly align supply and demand in a fast-moving market.
A Look at Cloud & Networking Revenue
Lumentum’s Cloud and Networking revenue was $313.8 million in Q3, up 9.5% QoQ and 7.1% YoY, with management saying the growth was driven by data center demand and its Cloud Light acquisition two quarters ago.
Cloud and networking revenue has grown sequentially since fiscal Q1, but management’s guidance calls for a sequential decline, including ~$40 million reduction from softer telecom demand, to ~$247.5 million in fiscal Q4. In order to reach management’s goal of exiting calendar 2025 with $500 million plus in quarterly revenue, Cloud and Networking revenue would likely need to grow upwards of 70% to $425 million or above.
Despite Optimism, Analysts Not Convinced of Growth
Despite management’s expressed optimism and explicit statements about reaching $500 million plus in quarterly revenue by the end of 2025, analysts aren’t convinced of this growth.
Current consensus estimates call for revenue of $489 million in the Dec 2025 quarter, just over 2% below management’s target, with the lowest estimate below $475 million, more than 5% below management’s target. Revenue growth also is not expected to return to double-digits until the June 2025 quarter, with estimates pointing to a nearly 40 percentage point acceleration from 6.8% to 45.6% growth.
In addition, revenue revisions are downward, signaling eroding confidence in the turnaround story. FY25’s revenue estimate of $1.51 billion has been revised (9.1%) lower over the past 3 months, while adjusted EPS of $1.67 has been revised (29.7%) lower, suggesting margin headwinds are expected to remain. The upcoming September and December quarters (fiscal Q1 and Q2 2025) have both seen revenue revised more than (13%) lower.
The doubts here about reaching and surpassing these revenue targets likely arises from a combination of factors – persisting softness in telecom weakness for multiple quarters more than anticipated, the tightrope walk for bringing capacity online to book new orders, and in general the six quarter-plus time frame between now and then. These types of revenue accelerations brought about by AI are what the Street has been rewarding recently, especially in hardware and data center players, hence why we’re tracking Lumentum and adding it to our momentum watchlist.
Valuation
Because of the top-line growth headwinds at the moment, Lumentum is trading at a discounted top-line valuation relative to its historical average since its IPO. Shares have traded at an average 2.9x PS multiple, as low as 1x around IPO and more recently 1.5x in October 2023, and as high as 5x in early 2021. Shares are currently trading at approximately 2.2x PS, and 2.3x forward PS due to the revenue declines we’re seeing.
Lumentum’s bottom line valuation is much more stretched, trading at 46.6x adjusted EPS for fiscal 2024, with adjusted EPS projected to decline (77%) this fiscal year due to the margin erosion we previously discussed. However, analysts forecast EPS to rebound quite rapidly in the back half of fiscal 2025 and continue this growth in 2026, with shares trading at an estimated 12.1x adjusted EPS for 2026.
Margins will be the first tell-tale sign of the pace and timing of this EPS rebound and growth, but the current pace of acceleration is attractive should Lumentum be able to hit or exceed analyst estimates.
As you can see, mid-2025 is currently the estimated time for Lumentum to see its rebound. This may seem far off, yet we are building our pipeline now for 2025 potentials and this is one we will continue to watch for when fundamentals and technicals align.
Competitors
Lumentum has a strong competitor in Marvell, with analysts seeing Marvell in “pole position” in the optical space with Inphi. Marvell reported over $1 billion in data center optics revenue in fiscal 2024, and projects electro-optics revenue to surpass $1 billion this year.
Marvell reported $816 million in data center revenue in Q1, up 87% YoY, driven by cloud AI, cloud infrastructure, and electro-optics. Management projected this “robust growth to continue from AI with the expected ramp in our cloud, custom AI programs to augment our substantial base of electro-optics revenue, which we expect will remain correlated to accelerator shipments.”
Electro-optics is expected to be a $1B+ business for Marvell this year, explaining that “from a full year perspective, the way to think about it, maybe some additional color would be, we talked about a floor of $1.5 billion for AI revenue for Marvell for this fiscal year with about 2/3 in electro-optics and a third in custom.” For more context, Marvell’s exit rate in Q4 was “well north of $200 million. And the bulk of that, as we said, was in optics.” Management also provided some clues that electro-optics growth will mirror the pace of AI accelerator growth, from 50% to 100% YoY. This growth is likely outpacing Lumentum’s growth, where management sees 60% growth form $300 million to $500 million over six quarters.
Conclusion
Lumentum has caught our attention as a potential beneficiary of AI capex spending from Big Tech, and while the majority of Big Tech’s budgets will be allocated to GPUs from Nvidia, physical data center infrastructure buildouts will require both AI servers and racks, and networking and optical components.
Lumentum’s management is eyeing data center demand to help drive a push to $500 million plus in quarterly revenues, or nearly new record levels, by the end of calendar 2025, though analysts aren’t fully convinced of the story, with estimates below management’s explicitly stated targets. The telecom inventory correction continues to weigh on revenues while margins have eroded substantially, providing two near-term headwinds to top line and bottom line growth, though forecasts point to strong accelerations in early calendar 2025.
We continue to watch Marvell for similar reasons, which is that telecom headwinds may subside while electro-optics and AI data center growth powers forward in the medium-term. Marvell is a stock we’ve owned in the past with coverage dating back to 2019, covered the Inphi acquisition, and various other reports found here. There is also a potential CXL memory catalyst, described here.back to 2019, covered the Inphi acquisition, and various other reports found here. There is also a potential CXL memory catalyst, described here.
Broadcom beat across the board with highlights including “just over” $11B in AI revenue expected and networking growth raised to 40% YoY growth, up from “over 35% growth” previously guided. The VMWare acquisition is one of the more intriguing points with management stating: “VMware revenue in Q1 was $2.1 billion, grew to $2.7 billion in Q2 and will accelerate towards a $4 billion per quarter run rate.”
As of now, Broadcom is expected to report over $11 billion in AI revenue this year, up from $10 billion. Additionally, the company beat on the top line and bottom line, and raised full year guidance.
Revenue and EPS:
Note: Broadcom completed the acquisition of VMware on Nov 22, 2023 and 11 months contribution from VMware is expected to be $12B for FY24
Revenue growth of 42.99% beat estimates for growth of 37.5% for revenue of $12.5 billion. Next quarter, Broadcom is expected to report revenue of $12.7 billion for growth of 43%.
For the fiscal year, the company is expected to report $51 billion in revenue for growth of 42.4%, up from a guide for $50 billion last quarter.
Adjusted EPS of $10.96 beat estimates of $10.84, which was flat QoQ yet was up $10.32 in the year ago quarter. Next quarter’s adjusted EPS is expected to be $11.90, for growth of 13%. GAAP EPS is lower than usual for Broadcom at $4.42 due to costs associated with the VMW acquisition. Per the CFO: “For modeling purposes, please keep in mind that GAAP net income and cash flows in fiscal year 2024 are impacted by restructuring and integration-related cash costs due to the VMware acquisition.”
Adjusted EBITDA was $7.4 billion, up from $7.15 billion last quarter. Adjusted EBITDA margin is 59.5% with management raising the guide for FY2024 to 61%, up from 60% previously guided. This is down from FY2023, which was 65% without VMWare.
Margins:
Margins expanded across the board with operating margin expanded 633 basis points QoQ. Per our pre-earnings writeup: “The merger integration process is expected to take a year and will initially have a drag on profit margins due to transition costs and VMware's lower margin profile. However, cost-cutting measures and merger synergies are anticipated to improve margins in the long term.”
Gross Margin of 62.27% increased QoQ from 61.66% although high 60% is more typical. This led to gross profit of $7.78 billion.
Adjusted gross margin of 76.2% expanded 84 basis points for adjusted gross profit of $9.51 billion.
GAAP operating margin of 23.74% expanded from 17.41% for operating income of $2.12 billion. This is typically in the mid-40% with the lower OPM being from costs associated with the VMW acquisition.
Adjusted operating margin of 57.3% was up 20 bps QoQ from 57.1% for adjusted operating profits of $7.14 billion. This is typically in the low 60-percent range.
Net margin of 16.99% is up 591 basis points for $2.12 billion in net income. This is typically in the high 30% range.
Adjusted net margin was 43.20% down 73 basis points for adjusted net income of $5.4 billion.
Cash:
Broadcom reported operating cash flow of $4.58 billion for OCF margin of 36.7%. Free cash flow of $4.45 billion represents a margin of 35.6%. The company has $9.8 billion in cash on the balance sheet and $74 billion in debt. This is up from $39 billion in debt two quarters ago due to the VMWare acquisition.
The company paid $2.4B in cash dividends based on a quarterly dividend of $5.25 per share. The company repaid $2B in debt in the quarter. Last quarter, the company stated they intend to continue paying $2 billion on the floating rate debt every quarter this year. Even though Broadcom has a high cash flow margin, the high debt is not ideal. You can find more details about the floating rate in our pre-earnings writeup.
Days sales outstanding is 40 days, down from 41 days last quarter. Inventory is at $1.8 billion compared to $1.9 billion last quarter.
Key Segments:
Semiconductor solutions grew 6% YoY to $7.2 billion and infrastructure software grew 175% YoY to $5.28 billion. As stated under the revenue section, 11 months contribution from VMWare is expected to be $12B or about $3.3 billion if we assume all things are equal, which means non-VMWare software revenue was flat. What’s important to monitor is the 15% QoQ growth as the restructuring VMWare is going through is expected to result in accelerating revenue. Last quarter, infrastructure software was $4.6 billion.
Networking revenue also grew 15% QoQ from $3.3 billion to $3.8 billion. This represents YoY growth of 44%. There were some strong statements about networking on the call, primarily this one: “Next year, we expect all mega-scale GPU deployments to be on Ethernet. We expect the strength in AI to continue, and because of that, we now expect networking revenue to grow 40% year-on-year compared to our prior guidance of over 35% growth.”Next year, we expect all mega-scale GPU deployments to be on Ethernet. We expect the strength in AI to continue, and because of that, we now expect networking revenue to grow 40% year-on-year compared to our prior guidance of over 35% growth.”
This quarter, Broadcom reported $3.1 billion in AI revenue with management stating they expect to end the year with “just over $11 billion in AI revenue.” Per discussions in the Q&A, this should be a minimum of $11.6 billion, with management being coy when asked why they weren’t guiding higher given H2 is supposed to be larger than H1: “So you may be right. You may estimate it better than I do, but the general trajectory is getting better. […]That's the best forecast I have at this point, Stacy.”
Server storage connectivity declined (27%) YoY to $824 million, which is a nominal improvement from last quarter when the segment declined (29%) YoY to $887 million. Per management, Q2 is expected to be a bottom in server storage and “we expected a modest recovery in the second half of the year.”
Broadband declined (39%) YoY to $730 million, which is steeper than last quarter when this segment declined (-23%) to $940 million. Broadband is “expected to bottom in H2 with a recovery in 2025.”
Wireless grew 2% YoY to $1.6 billion but was down QoQ due to seasonality. The company expects FY2024 to be flat this year.
Per a Bloomberg report, Apple is expected to replace some of its Broadcom chips with custom chips in 2025. This will reduce the customer concentration of Apple from 20% to 12%-15%.
Note on Valuation:
Broadcom is trading above historic averages with PS ratio prior to earnings of 16 compared to historic 5-year average of 8. The PE Ratio prior to earnings was 52 compared to a historic average of 40. AI semis have been seeing higher-than-usual valuations and where the market settles on this long-term is anyone’s guess, but over the past year or so, the market has given a premium valuation to AI-related semis.
Q&A:
Networking Update:
The statement that: “next year, we expect all mega-scale GPU deployments to be on Ethernet” is when Broadcom saw even stronger price action after hours. This is sooner than most expected. We covered the differences between InfiniBand and Ethernet in our Broadcom writeup here: “Broadcom: Networking/ASICs Giant and Second Largest By AI Revenue.”
That comment is interesting because InfiniBand accounts for over $10 billion in revenue for Nvidia. There were questions on how Broadcom plans to compete with Nvidia, with the CEO pointing out that they’ve been a leader in Ethernet for decades.
Per the opening remarks: “Networking these AI accelerators is very challenging but the technology does exist today. In Broadcom, we have the deepest and broadest understanding of what it takes for complex, large workloads to be scaled out in an AI fabric. Proof in point, 7 of the largest 8 AI clusters in deployment today use Broadcom Ethernet solutions.”
From my perspective, the impetus for the market moving toward Ethernet is to shake up Nvidia’s iron grip on the market, and thus, Broadcom should be a first-place contender. That’s speculative, but a reasonable and investable assumption. Per my previous write-up: “[Benefits of Ethernet]: Large pool of vendors whereas InfiniBand increases dependency on Nvidia. For this reason, AWS and Google Cloud have remained on Ethernet as they prioritize custom silicon.”
In other words, despite being an Nvidia bull, I do not think Spectrum X will take the Ethernet market. I think Broadcom will remain the leader.
Here is the Q&A portion on this topic. We are interested in the second part as it’s understood that ASICs and GPUs do not compete, rather they are going to coexist.
Question
Vivek Arya (Analyst):
Hock, I would appreciate your perspective on the emerging competition between Broadcom and NVIDIA across both accelerators and Ethernet switching. So on the accelerator side, they are going to launch their Blackwell product that many of the same customers that you have a very large position in the custom compute. So I'm curious how you think customers are going to do that allocation decision, just broadly what the visibility is.
And then I think part B of that is as they launch their Spectrum-X Ethernet switch, do you think that poses increasing competition for Broadcom and the Ethernet switching side in AI for next year?
Answer
Hock Tan (Executive):
Very interesting question, Vivek.
On AI accelerators, I think we are operating on a different — to start with scale, much a different model. It is — and on the GPUs, which are the AI accelerator of choice on merchant — in a merchant environment is something that is extremely powerful as a model and it's something that NVIDIA operates in, in a very, very effective manner. We don't even think about competing against them in that space, not in the least. That's where they're very good at and we know where we stand with respect to that.
Now what we do for very selected or selective hyperscalers is if there's a scale and the skills to try to create silicon solutions, which are AI accelerators, to do particular very complex AI workloads, we're happy to use our IP portfolio to create those custom ASIC AI accelerator. So I do not see them as truly competing against each other. And far for me to say I'm trying to position myself to be a competitor on basically GPUs in this market. We're not. We are not a competitor to them. We don't try to be either.
Now on networking, maybe that's different. But again, people may be approaching and they may be approaching it from a different angle. We are, as I indicated all along, very deep in Ethernet as we've been doing Ethernet for over 25 years, Ethernet networking. And we've gone through a lot of market transitions, and we have captured a lot of market transitions from cloud-scale networking to routing and now AI. So it's a natural extension for us to go into AI.
We also recognize that being the AI compute engine of choice in merchants in the ecosystem, which is GPUs, that they are trying to create a platform that is probably end to end very integrated. We take the approach that we don't do those GPUs, but we enable the GPUs to work very well. So if anything else, we supplement and hopefully complement those GPUs with customers who are building bigger and bigger GPU clusters.”
Tomahawk 6 Coming End of 2025:
On the topic of Broadcom’s leadership in Ethernet, this was a key Q&A moment as to how Broadcom intends to stay in the lead on networking:
“Question Harlan Sur (Analyst)
[…] it's been 2 years since you've introduced Tomahawk 5 product introduction, right, which if I look back historically, means you have silicon and are getting ready to introduce your next-generation 3-nanometer Tomahawk 6 products, which would, I think, puts you 2 to 3 years ahead of your competitors. Can you just give us an update there?
Answer Hock Tan (Executive)
Harlan, you're pretty insightful there. Yes, we launched Tomahawk 5 '23. So you're right, by late '25, the time we should be coming out with Tomahawk 6, which is the 100-terabit switch, yes.”
VMWare Update:
Management provided a key update on VWM this quarter: “VMware revenue in Q1 was $2.1 billion, grew to $2.7 billion in Q2 and will accelerate towards a $4 billion per quarter run rate. We therefore expect operating margins for VMware to begin to converge towards that of classic Broadcom software by fiscal 2025.”
The restructuring of VMWare has been controversial and bold. Broadcom’s management team terminated partner agreements, laid off thousands of employees and restructured its perpetual licensing terms to narrow its focus from 300,000 customers down to the 10,000 A-list customers that can drive the most revenue. From there, the company forced resellers to reapply and increased pricing for many customers.
To illustrate the overhaul, the CEO stated in the opening remarks: “The integration of VMware is going very well. Since we acquired VMware, we have modernized the product SKUs from over 8,000 disparate SKUs to 4 core product offerings and simplified the go-to-market flow, eliminating a huge amount of channel conflicts.”we have modernized the product SKUs from over 8,000 disparate SKUs to 4 core product offerings and simplified the go-to-market flow, eliminating a huge amount of channel conflicts.”
This was also offered: “We are making good progress in transitioning all VMware products to a subscription licensing model. And since closing the deal, we have actually signed up close to 3,000 of our largest 10,000 customers to enable them to build a self-service virtual private cloud on-prem. Each of these customers typically sign up to a multiyear contract, which we normalize into an annual measure known as annualized booking value or ABV. This metric, ABV, for VMware products accelerated from $1.2 billion in Q1 to $1.9 billion in Q2. For a reference, for the consolidated Broadcom software portfolio, ABV grew from $1.9 billion in Q1 to $2.8 billion over the same period in Q2.”transitioning all VMware products to a subscription licensing model.And since closing the deal, we have actually signed up close to 3,000 of our largest 10,000 customers to enable them to build a self-service virtual private cloud on-prem. Each of these customers typically sign up to a multiyear contract, which we normalize into an annual measure known as annualized booking value or ABV. This metric, ABV, for VMware products accelerated from $1.2 billion in Q1 to $1.9 billion in Q2. For a reference, for the consolidated Broadcom software portfolio, ABV grew from $1.9 billion in Q1 to $2.8 billion over the same period in Q2.”
“During its AI Infrastructure Investor meeting held in March, the company announced its third AI ASIC customer. Charlie Kawwas, Broadcom's President, Semiconductor Solutions Group, said, “Well, since you're all here today and you traveled here, we wanted to actually share with you that we actually have a third customer. I don't hear any excitement. Come on. So we're very, very honored and pleased and happy to tell you that third customer is also in the consumer AI space and we are in the ramp phase and we will be shipping products in the next few months to that customer. And this is something that we believe will continue as well over the next few years.”
This is certainly big since the CEO mentioned, “it takes years. It takes a lot of heavy lifting to create that custom silicon because you need to do more than just hardware of silicon to really have a solution for generative…” The company counts Google and Meta as the first two customers and JP Morgan believes that the third could be ByteDance. They also believe that the company has recently won follow-on orders from Google and Meta.
"Overall, we estimate that Google and Meta combined will drive $9B+ in AI ASIC chip revenues for Broadcom this year (Google ~$8B+ and Meta around $500M-$1B), up almost 2.5x over CY23," wrotetheanalyst. "More importantly, as we said back in 2022, we believe that Meta remains on track to become Broadcom's next multi-billion dollar per year AI ASIC customer potentially starting in CY25." JP Morgan estimates that the AI revenue to be $10 billion to $12 billion for FY2024, driven by the third customer, strong demand for Tomahawk 5 and Jericho 3 switching/routing chipsets and PCIe Gen5/Gen6 switches.
Conclusion:
We are also seeing early shoots on AI software and AI custom silicon. Pick a direction in AI, and if you look closely enough, you’ll see Broadcom is not “standing still.” That’s the CEO’s words, not mine, but I think it perfectly describes an old school networking giant that has managed to innovate and hang with some of the cooler, hipper AI design companies.
Although I have become known for the Nvidia call, the team is working overtime to bring you other AI opportunities. Broadcom is a strong contender and we are pleased to be positioned here ahead of ethernet taking more market share on GPU networking (where InfiniBand is the leader today).
GPU clusters are only going to grow (this was covered last week on the free side). Nvidia will push Spectrum X for its benefits of a tight integration, yet Big Tech may want to resist handing the keys to the kingdom to Nvidia. We will see, but that’s my hunch. Broadcom is number one today on ethernet networking and I don’t think this is going to change.
Pro premium members receive deep-dive research on all the stocks in the portfolio and quarterly earnings kickoff webinars. In addition, the Advanced Market Signals Members receive regular technical and broad market analysis and weekly webinars from our Portfolio Manager, Knox Ridley. We closed Super Micro in early May for an average gain of 275% across all entries and exits. Also, we booked sizable gains in two cybersecurity stocks in April. Learn more here.We closed Super Micro in early May for an average gain of 275% across all entries and exits. Also, we booked sizable gains in two cybersecurity stocks in April. Learn more here.
Broadcom beat across the board with highlights including “just over” $11B in AI revenue expected and networking growth raised to 40% YoY growth, up from “over 35% growth” previously guided. The VMWare acquisition is one of the more intriguing points with management stating: “VMware revenue in Q1 was $2.1 billion, grew to $2.7 billion in Q2 and will accelerate towards a $4 billion per quarter run rate.”
As of now, Broadcom is expected to report over $11 billion in AI revenue this year, up from $10 billion. Additionally, the company beat on the top line and bottom line, and raised full year guidance.
Revenue and EPS:
Note: Broadcom completed the acquisition of VMware on Nov 22, 2023 and 11 months contribution from VMware is expected to be $12B for FY24
Revenue growth of 42.99% beat estimates for growth of 37.5% for revenue of $12.5 billion. Next quarter, Broadcom is expected to report revenue of $12.7 billion for growth of 43%.
For the fiscal year, the company is expected to report $51 billion in revenue for growth of 42.4%, up from a guide for $50 billion last quarter.
Adjusted EPS of $10.96 beat estimates of $10.84, which was flat QoQ yet was up $10.32 in the year ago quarter. Next quarter’s adjusted EPS is expected to be $11.90, for growth of 13%. GAAP EPS is lower than usual for Broadcom at $4.42 due to costs associated with the VMW acquisition. Per the CFO: “For modeling purposes, please keep in mind that GAAP net income and cash flows in fiscal year 2024 are impacted by restructuring and integration-related cash costs due to the VMware acquisition.”
Adjusted EBITDA was $7.4 billion, up from $7.15 billion last quarter. Adjusted EBITDA margin is 59.5% with management raising the guide for FY2024 to 61%, up from 60% previously guided. This is down from FY2023, which was 65% without VMWare.
Margins:
Margins expanded across the board with operating margin expanded 633 basis points QoQ. Per our pre-earnings writeup: “The merger integration process is expected to take a year and will initially have a drag on profit margins due to transition costs and VMware's lower margin profile. However, cost-cutting measures and merger synergies are anticipated to improve margins in the long term.”
Gross Margin of 62.27% increased QoQ from 61.66% although high 60% is more typical. This led to gross profit of $7.78 billion.
Adjusted gross margin of 76.2% expanded 84 basis points for adjusted gross profit of $9.51 billion.
GAAP operating margin of 23.74% expanded from 17.41% for operating income of $2.12 billion. This is typically in the mid-40% with the lower OPM being from costs associated with the VMW acquisition.
Adjusted operating margin of 57.3% was up 20 bps QoQ from 57.1% for adjusted operating profits of $7.14 billion. This is typically in the low 60-percent range.
Net margin of 16.99% is up 591 basis points for $2.12 billion in net income. This is typically in the high 30% range.
Adjusted net margin was 43.20% down 73 basis points for adjusted net income of $5.4 billion.
Cash:
Broadcom reported operating cash flow of $4.58 billion for OCF margin of 36.7%. Free cash flow of $4.45 billion represents a margin of 35.6%. The company has $9.8 billion in cash on the balance sheet and $74 billion in debt. This is up from $39 billion in debt two quarters ago due to the VMWare acquisition.
The company paid $2.4B in cash dividends based on a quarterly dividend of $5.25 per share. The company repaid $2B in debt in the quarter. Last quarter, the company stated they intend to continue paying $2 billion on the floating rate debt every quarter this year. Even though Broadcom has a high cash flow margin, the high debt is not ideal. You can find more details about the floating rate in our pre-earnings writeup.
Days sales outstanding is 40 days, down from 41 days last quarter. Inventory is at $1.8 billion compared to $1.9 billion last quarter.
Key Segments:
Semiconductor solutions grew 6% YoY to $7.2 billion and infrastructure software grew 175% YoY to $5.28 billion. As stated under the revenue section, 11 months contribution from VMWare is expected to be $12B or about $3.3 billion if we assume all things are equal, which means non-VMWare software revenue was flat. What’s important to monitor is the 15% QoQ growth as the restructuring VMWare is going through is expected to result in accelerating revenue. Last quarter, infrastructure software was $4.6 billion.
Networking revenue also grew 15% QoQ from $3.3 billion to $3.8 billion. This represents YoY growth of 44%. There were some strong statements about networking on the call, primarily this one: “Next year, we expect all mega-scale GPU deployments to be on Ethernet. We expect the strength in AI to continue, and because of that, we now expect networking revenue to grow 40% year-on-year compared to our prior guidance of over 35% growth.”Next year, we expect all mega-scale GPU deployments to be on Ethernet. We expect the strength in AI to continue, and because of that, we now expect networking revenue to grow 40% year-on-year compared to our prior guidance of over 35% growth.”
This quarter, Broadcom reported $3.1 billion in AI revenue with management stating they expect to end the year with “just over $11 billion in AI revenue.” Per discussions in the Q&A, this should be a minimum of $11.6 billion, with management being coy when asked why they weren’t guiding higher given H2 is supposed to be larger than H1: “So you may be right. You may estimate it better than I do, but the general trajectory is getting better. […]That's the best forecast I have at this point, Stacy.”
Server storage connectivity declined (27%) YoY to $824 million, which is a nominal improvement from last quarter when the segment declined (29%) YoY to $887 million. Per management, Q2 is expected to be a bottom in server storage and “we expected a modest recovery in the second half of the year.”
Broadband declined (39%) YoY to $730 million, which is steeper than last quarter when this segment declined (-23%) to $940 million. Broadband is “expected to bottom in H2 with a recovery in 2025.”
Wireless grew 2% YoY to $1.6 billion but was down QoQ due to seasonality. The company expects FY2024 to be flat this year.
Per a Bloomberg report, Apple is expected to replace some of its Broadcom chips with custom chips in 2025. This will reduce the customer concentration of Apple from 20% to 12%-15%.
Note on Valuation:
Broadcom is trading above historic averages with PS ratio prior to earnings of 16 compared to historic 5-year average of 8. The PE Ratio prior to earnings was 52 compared to a historic average of 40. AI semis have been seeing higher-than-usual valuations and where the market settles on this long-term is anyone’s guess, but over the past year or so, the market has given a premium valuation to AI-related semis.
Q&A:
Networking Update:
The statement that: “next year, we expect all mega-scale GPU deployments to be on Ethernet” is when Broadcom saw even stronger price action after hours. This is sooner than most expected. We covered the differences between InfiniBand and Ethernet in our Broadcom writeup here: “Broadcom: Networking/ASICs Giant and Second Largest By AI Revenue.”
That comment is interesting because InfiniBand accounts for over $10 billion in revenue for Nvidia. There were questions on how Broadcom plans to compete with Nvidia, with the CEO pointing out that they’ve been a leader in Ethernet for decades.
Per the opening remarks: “Networking these AI accelerators is very challenging but the technology does exist today. In Broadcom, we have the deepest and broadest understanding of what it takes for complex, large workloads to be scaled out in an AI fabric. Proof in point, 7 of the largest 8 AI clusters in deployment today use Broadcom Ethernet solutions.”
From my perspective, the impetus for the market moving toward Ethernet is to shake up Nvidia’s iron grip on the market, and thus, Broadcom should be a first-place contender. That’s speculative, but a reasonable and investable assumption. Per my previous write-up: “[Benefits of Ethernet]: Large pool of vendors whereas InfiniBand increases dependency on Nvidia. For this reason, AWS and Google Cloud have remained on Ethernet as they prioritize custom silicon.”
In other words, despite being an Nvidia bull, I do not think Spectrum X will take the Ethernet market. I think Broadcom will remain the leader.
Here is the Q&A portion on this topic. We are interested in the second part as it’s understood that ASICs and GPUs do not compete, rather they are going to coexist.
Question
Vivek Arya (Analyst):
Hock, I would appreciate your perspective on the emerging competition between Broadcom and NVIDIA across both accelerators and Ethernet switching. So on the accelerator side, they are going to launch their Blackwell product that many of the same customers that you have a very large position in the custom compute. So I'm curious how you think customers are going to do that allocation decision, just broadly what the visibility is.
And then I think part B of that is as they launch their Spectrum-X Ethernet switch, do you think that poses increasing competition for Broadcom and the Ethernet switching side in AI for next year?
Answer
Hock Tan (Executive):
Very interesting question, Vivek.
On AI accelerators, I think we are operating on a different — to start with scale, much a different model. It is — and on the GPUs, which are the AI accelerator of choice on merchant — in a merchant environment is something that is extremely powerful as a model and it's something that NVIDIA operates in, in a very, very effective manner. We don't even think about competing against them in that space, not in the least. That's where they're very good at and we know where we stand with respect to that.
Now what we do for very selected or selective hyperscalers is if there's a scale and the skills to try to create silicon solutions, which are AI accelerators, to do particular very complex AI workloads, we're happy to use our IP portfolio to create those custom ASIC AI accelerator. So I do not see them as truly competing against each other. And far for me to say I'm trying to position myself to be a competitor on basically GPUs in this market. We're not. We are not a competitor to them. We don't try to be either.
Now on networking, maybe that's different. But again, people may be approaching and they may be approaching it from a different angle. We are, as I indicated all along, very deep in Ethernet as we've been doing Ethernet for over 25 years, Ethernet networking. And we've gone through a lot of market transitions, and we have captured a lot of market transitions from cloud-scale networking to routing and now AI. So it's a natural extension for us to go into AI.
We also recognize that being the AI compute engine of choice in merchants in the ecosystem, which is GPUs, that they are trying to create a platform that is probably end to end very integrated. We take the approach that we don't do those GPUs, but we enable the GPUs to work very well. So if anything else, we supplement and hopefully complement those GPUs with customers who are building bigger and bigger GPU clusters.”
Tomahawk 6 Coming End of 2025:
On the topic of Broadcom’s leadership in Ethernet, this was a key Q&A moment as to how Broadcom intends to stay in the lead on networking:
“Question Harlan Sur (Analyst)
[…] it's been 2 years since you've introduced Tomahawk 5 product introduction, right, which if I look back historically, means you have silicon and are getting ready to introduce your next-generation 3-nanometer Tomahawk 6 products, which would, I think, puts you 2 to 3 years ahead of your competitors. Can you just give us an update there?
Answer Hock Tan (Executive)
Harlan, you're pretty insightful there. Yes, we launched Tomahawk 5 '23. So you're right, by late '25, the time we should be coming out with Tomahawk 6, which is the 100-terabit switch, yes.”
VMWare Update:
Management provided a key update on VWM this quarter: “VMware revenue in Q1 was $2.1 billion, grew to $2.7 billion in Q2 and will accelerate towards a $4 billion per quarter run rate. We therefore expect operating margins for VMware to begin to converge towards that of classic Broadcom software by fiscal 2025.”
The restructuring of VMWare has been controversial and bold. Broadcom’s management team terminated partner agreements, laid off thousands of employees and restructured its perpetual licensing terms to narrow its focus from 300,000 customers down to the 10,000 A-list customers that can drive the most revenue. From there, the company forced resellers to reapply and increased pricing for many customers.
To illustrate the overhaul, the CEO stated in the opening remarks: “The integration of VMware is going very well. Since we acquired VMware, we have modernized the product SKUs from over 8,000 disparate SKUs to 4 core product offerings and simplified the go-to-market flow, eliminating a huge amount of channel conflicts.”we have modernized the product SKUs from over 8,000 disparate SKUs to 4 core product offerings and simplified the go-to-market flow, eliminating a huge amount of channel conflicts.”
This was also offered: “We are making good progress in transitioning all VMware products to a subscription licensing model. And since closing the deal, we have actually signed up close to 3,000 of our largest 10,000 customers to enable them to build a self-service virtual private cloud on-prem. Each of these customers typically sign up to a multiyear contract, which we normalize into an annual measure known as annualized booking value or ABV. This metric, ABV, for VMware products accelerated from $1.2 billion in Q1 to $1.9 billion in Q2. For a reference, for the consolidated Broadcom software portfolio, ABV grew from $1.9 billion in Q1 to $2.8 billion over the same period in Q2.”transitioning all VMware products to a subscription licensing model.And since closing the deal, we have actually signed up close to 3,000 of our largest 10,000 customers to enable them to build a self-service virtual private cloud on-prem. Each of these customers typically sign up to a multiyear contract, which we normalize into an annual measure known as annualized booking value or ABV. This metric, ABV, for VMware products accelerated from $1.2 billion in Q1 to $1.9 billion in Q2. For a reference, for the consolidated Broadcom software portfolio, ABV grew from $1.9 billion in Q1 to $2.8 billion over the same period in Q2.”
“During its AI Infrastructure Investor meeting held in March, the company announced its third AI ASIC customer. Charlie Kawwas, Broadcom's President, Semiconductor Solutions Group, said, “Well, since you're all here today and you traveled here, we wanted to actually share with you that we actually have a third customer. I don't hear any excitement. Come on. So we're very, very honored and pleased and happy to tell you that third customer is also in the consumer AI space and we are in the ramp phase and we will be shipping products in the next few months to that customer. And this is something that we believe will continue as well over the next few years.”
This is certainly big since the CEO mentioned, “it takes years. It takes a lot of heavy lifting to create that custom silicon because you need to do more than just hardware of silicon to really have a solution for generative…” The company counts Google and Meta as the first two customers and JP Morgan believes that the third could be ByteDance. They also believe that the company has recently won follow-on orders from Google and Meta.
"Overall, we estimate that Google and Meta combined will drive $9B+ in AI ASIC chip revenues for Broadcom this year (Google ~$8B+ and Meta around $500M-$1B), up almost 2.5x over CY23," wrotetheanalyst. "More importantly, as we said back in 2022, we believe that Meta remains on track to become Broadcom's next multi-billion dollar per year AI ASIC customer potentially starting in CY25." JP Morgan estimates that the AI revenue to be $10 billion to $12 billion for FY2024, driven by the third customer, strong demand for Tomahawk 5 and Jericho 3 switching/routing chipsets and PCIe Gen5/Gen6 switches.
Conclusion:
We are also seeing early shoots on AI software and AI custom silicon. Pick a direction in AI, and if you look closely enough, you’ll see Broadcom is not “standing still.” That’s the CEO’s words, not mine, but I think it perfectly describes an old school networking giant that has managed to innovate and hang with some of the cooler, hipper AI design companies.
Although I have become known for the Nvidia call, the team is working overtime to bring you other AI opportunities. Broadcom is a strong contender and we are pleased to be positioned here ahead of ethernet taking more market share on GPU networking (where InfiniBand is the leader today).
GPU clusters are only going to grow (this was covered last week on the free side). Nvidia will push Spectrum X for its benefits of a tight integration, yet Big Tech may want to resist handing the keys to the kingdom to Nvidia. We will see, but that’s my hunch. Broadcom is number one today on ethernet networking and I don’t think this is going to change.
We said to our free readers in late January following the SEC’s approval of nearly one dozen spot Bitcoin ETFs that it was “widely expected that this approval and subsequent widespread access for institutions and retail investors will shape up to be one of the most bullish fundamental moments in Bitcoin’s history.” At the time, Bitcoin was trading for less than $40,000. Now, Bitcoin has repeatedly pushed above the $70,000 mark, and we updated our Bitcoin game plan and price targets to $106K to $190K in late April as Bitcoin pulled back below $60,000.
While Bitcoin and the spot BTC ETFs have clearly seen strong investor appetite since the approval in the beginning of the year – for example, BlackRock’s iShares Bitcoin Trust (IBIT) reached $10 billion in AUM in less than seven weeks as it went on to notch 71 consecutive days of net inflows. IBIT now has more than $23 billion in AUM, or 305,067 BTC, more than doubling in three months. Alongside strong initial adoption of the new ETF class, we’re also seeing major crypto exchanges and platforms benefit, with Coinbase and Robinhood both seeing crypto trading volumes and transaction revenues surge.
This may cause investors to believe that Coinbase and Robinhood are clear beneficiaries, yet we foresee trouble for HOOD specifically. Our firm excels at using technical analysis to manage high beta positions, which is why our Bitcoin entries and exits have greatly outperformed a buy-and-hold strategy, as we previously detailed here. Not only are the technicals flashing on Robinhood but the fundamentals show concentration risk in Dogecoin, one of the riskiest coins on the market. We spell out what it could mean for our readers, and why Robinhood is (yet again) a risk to both investors and crypto holders.
Coinbase Says Crypto Volatility Ticked Up in Q1
After reaching the lowest levels since 2016 in Q3 last year, crypto volatility has begun to increase, with Coinbase noting that an internal measurement of crypto asset volatility rose “sharply, but remained well below all-time high levels.”
Coinbase measures volatility “based on intraday returns of a volume-weighted basket of all assets listed on our trading platform [which] are used to compute the basket’s intraday volatility which is then scaled to a daily window. These daily volatility values are then averaged over the applicable time period as needed.”
Alongside this rise in crypto volatility towards the 5% range, Coinbase noted a surge in the crypto market cap, which “reached a 52-week high of approximately $2.8 trillion in Q1.” This also returned to the peak levels seen in Q3 and Q4 2021, which coincided with both Coinbase’s and Robinhood’s record high transaction revenues and trading volumes. Coinbase said that while it cannot identify a specific singular driver of this increase in crypto market cap through Q1, it pointed to “a variety of factors, such as the launch of the Bitcoin ETFs which experienced over $11 billion in net inflows so far in 2024.”
While we saw the pace of inflows slow to a crawl through April and May, June so far has seen inflows top the $500 million mark once again, recording the second highest daily net inflow since the start of the year at more than $886 million.
Crypto market cap has stayed relatively flat this quarter so far compared to Q1, last reaching $2.68 trillion on June 11, just 7% below its peak of $2.89 trillion in early March. This was aided by the SEC’s initial approval of 8 Ethereum ETFs in late May and a 20% rise in ETH – another possible volatility-spurring event. Overall, Q1 saw very favorable conditions for Coinbase and Robinhood to accelerate trading volume growth and transaction revenue generation with an increase in volatility along with rising crypto prices, and these conditions look to have persisted through much of Q2 so far, albeit with a slowdown in net inflows to BTC ETFs early in the quarter.
Both Coinbase and Robinhood reported significant accelerations in trading volumes in Q1, with participation from both retail and institutional investors increasing.
Coinbase reported total trading volume of $312 billion, a 103% QoQ increase from $154 billion in Q4, and a 312% increase from Q3’s low of $76 billion. Growth was driven by both retail and institutional customers, though as Coinbase’s largest and primary customer group, institutions drove a lion’s share (83%) of the dollar increase in trading volume.
Source: I/O Fund
Institutional trading volume of $256 billion represented a 105% QoQ increase, or $131 billion, reaching the highest level since Q1 2022. Retail trading volume rose 93% QoQ to $56 billion in Q1, more than 5x higher than Q3’s $11 billion. Bitcoin was the primary driver of the QoQ increase in trading volume, with Bitcoin’s volume rising from below $48 billion in Q4 to $103 billion in Q1.
Robinhood’s crypto trading volume growth outpaced Coinbase’s in Q1, though at a much smaller base due to the lack of institutional investors on the platform. Robinhood reported 224% YoY and 181% QoQ growth in crypto trading volume to $36 billion, or 429% higher than Q3’s $6.8 billion. This growth was driven primarily by a surge in volume in March, where Robinhood reported $23.6 billion in volume, a 263% MoM increase.
Source: I/O Fund
Robinhood also has shared April and May’s crypto trading volume metrics, reporting trading volume of $10.1 billion in April, a (57%) MoM decline but a 173% YoY increase. May’s crypto trading volume slipped (30%) MoM to $7.1 billion; this still represented a strong 238% YoY increase. We’re seeing one primary asset driving this growth in Q1 and this sequential MoM weakness through Q2, which raises one red flag for the durability of transaction revenue growth moving forward.
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As a result of the rapid acceleration in crypto trading volumes across Coinbase and Robinhood, the two are seeing transaction revenues surge. In Robinhood’s case, crypto is now becoming a much larger part of transaction revenues and thus overall revenues.
Coinbase reported transaction revenue of $1.08 billion in Q1, including $56 million of Base and payment related revenue. This represented YoY growth of 187% and QoQ growth of 103%, an acceleration from Q4’s 64% YoY and 83% QoQ growth. In just two quarters, Coinbase’s transaction revenue has risen nearly 275% due to accelerating growth in retail trading volume.
Source: I/O Fund
Retail (consumer) transaction revenue increased 184% YoY and 99% QoQ; in dollar terms, revenue increased nearly $470 million from last quarter on a $27 billion increase in volume. Institutional transaction revenue approached levels last seen in Q4 2021, reaching $85.4 million in Q1. Revenue from this cohort has increased $71 million over the last two quarters, as trading volume surged nearly $200 billion.
Coinbase shared some light on Q2’s outlook, saying that “in April, we generated over $300 million of total transaction revenue and expect Q2 subscription and services revenue to be within a range of $525-$600 million, assuming crypto asset prices stay in the range we have seen year to date.” Extrapolating this across May and June suggests Q2’s total transaction revenues are set to decline sequentially, by approximately (10%) to (15%).
This highlights two major facets of Coinbase’s model – while institutions drive a majority of volume on the platform, the transaction fees are a tiny fraction of what retail pays, meaning that strong growth in institutional volume will barely be felt on the top line. It also highlights that despite increasing fee-based competition from both Robinhood and ETFs, Coinbase is driving revenues higher on smaller volumes than it had seen in 2021. This means that if crypto adoption and volatility brings trading volumes near peak 2021’s levels, revenue is likely to easily exceed those historical peaks. However, transaction revenue growth may have peaked for the short term, given April’s results and trends seen in Robinhood.
For Robinhood, crypto is but one of the many investing products offered on the platform alongside equities and options, with options historically serving as the largest driver of transaction revenue. Crypto transaction revenue was $126 million in Q1, an increase of 232% YoY and 193% QoQ. Compared to Q3 2023, it’s an increase of nearly 448%.
Source: I/O Fund
Robinhood Has Nearly as Much Doge as Bitcoin = High Risk
Crypto transaction revenue now accounts for 38% of Robinhood’s total transaction revenue, up from 22% last quarter and 12% in Q3. This was crypto’s highest share of transaction revenue since Q2 2021, where it drove 52% on elevated interest and extreme trading volume in Dogecoin, which accounted for 62% of crypto trading volume in the quarter.
Dogecoin remains a critical piece of Robinhood’s crypto business and a likely driver of recent growth alongside Bitcoin – safeguarded customer assets of Dogecoin increased 122% QoQ to $7.37 billion, or 28% of total safeguarded crypto assets. For comparison, safeguarded Bitcoin assets rose just 68% QoQ to $10.31 billion.
It's likely that a majority of March’s $23.6 billion in crypto trading volume can be traced back to Dogecoin, with the same going for April and May. March saw extreme volatility in Dogecoin’s price as it topped $0.20, with daily volumes regularly topping 3 billion, and reaching as high as over 12 billion, whereas in January and February daily volume rarely surpassed 2 billion. Daily volume remained elevated in April as Robinhood reported more than $10 billion in crypto trading volume, while Doge’s volume has dipped in May where Robinhood’s crypto volume declined (30%) MoM.
This raises a question of how durable transaction revenue growth is, assuming crypto trading volumes decline (30%) QoQ in Q2 on fading volume in Dogecoin, and plateau in Q3. Trading volumes are continuing to slip MoM, as seen in April and May’s results, providing a headwind to transaction revenue growth as this elevated volatility in Dogecoin dissipates.
Robinhood received a Wells Notice in early May regarding crypto tokens listed on the platform, though it is not clear exactly which tokens the SEC is targeting in the notice. Robinhood CFO Jason Warnick explained in Q1’s earnings call that it is “business as usual for Robinhood Crypto. We're, of course, disappointed to have received the notice. As you know, we've operated our crypto business in good faith. We've been very conservative in our approach in terms of coins listed and services offered. And we're a highly regulated company and have applied the same legal and compliance standards we use for our brokerage to the way we run our crypto business. So, it's disappointing to see more regulation by enforcement here.” At the same time, Robinhood is working on expanding its crypto presence globally, buying BitStamp for $200 million.
Robinhood’s High Concentration Risk in Dogecoin
As a reminder, Dogecoin contributed 62% of Robinhood's revenue in the previous crypto run-up, which did not end well for investors as the high concentration contributed to the stock losing 90% of its value as Dogecoin’s hype and price faded shortly after Robinhood’s IPO.
We can clearly see how Doge’s price and volatility are correlated to Robinhood’s trading volume and transaction revenue growth.
Doge’s price surged to the pennies in Q1 2021 on more than 850 billion in volume, with Robinhood reporting nearly $88 billion in trading volume. Q2 2021 saw Doge’s price surge above $0.70 on extreme volatility with volume of 680 billion, driving Robinhood’s Q2 2021 trading volume up to $233 billion, a 3x QoQ increase. Transaction revenues soared from $12 million in Q4 2020 to $233 million in Q2 2021, a remarkable growth rate in just two quarters. However, this quickly faded to $51 million in Q3 2021 as Dogecoin’s volatility and volume faded quickly.
Trading volume declined steadily hand-in-hand with Doge through 2023 – October 2022’s pop in Doge drove a 16% MoM increase in Robinhood’s trading volume from $15.5 billion to $18 billion, which quickly dropped to below $15 billion in November and continued its trend of declining consistently. Doge’s recent increase again has correlated with increased volumes and transaction revenues for Robinhood in the first quarter, but has led to declining trading volumes and likely transaction revenue for Q2.
Analysts seemed to poke about Robinhood’s heavy concentration and reliance on Doge in Q1’s call, though management’s response was very vague.
Q, Brian Bertram Bedell (Deutsche Bank): “Maybe just staying on the crypto theme, maybe for Jason, if you can talk about just the nature of the surge in crypto volumes in March. And I think you said April was at $10 billion. I appreciate, of course, this is very volatile class, but maybe if you can just talk about what you're seeing that drove that heavy activity in March and whether you think we could see spikes like that again?”
A, Vladimir Tenev (CEO): “…Our crypto activity does track the broader market. And I don't really want to get into prognosticating what the crypto market is going to do. That's obviously a difficult thing for anyone to do. It's a global market. … But the goal is also to diversify the business so that we're less reliant on volumes anywhere in any one category to drive business results.”
While management vaguely pointed to the broader market as a driver of growth, the comments about diversifying away from one asset again hints at Dogecoin being a primary driver of trading volume and transaction revenue growth, further supported by safeguarded assets more than doubling QoQ.
This heavy reliance on a memecoin raises risks for durable crypto revenue growth outside of Dogecoin, and we have seen cases where companies with heavy customer concentration have failed to deliver for investors. For example, AI lending platform Upstart, which has faced significant macro headwinds recently, had significant customer concentration, with two customers combining for more than 80% of revenue in both 2020 and 2021. Prior to the first rate hike in March 2022 and before feeling the effects of the challenging macro in Q2 2022, Upstart had lost more than two-thirds of its value.
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Forward Growth Rates Are Low
Despite strong growth in Q1, both Coinbase and Robinhood’s forward revenue growth rates are forecast to slow to a crawl, with sequential growth barely visible, if at all, with minimal single digit growth forecast for 2025 and 2026.
Source: I/O Fund
For Q2, Coinbase is estimated to see revenue decline almost (15%) QoQ, likely driven by softer transaction revenues. Sequential growth is limited through Q1 2025, with revenues estimated to hover around $1.4 billion. Robinhood is in a similar camp, with it estimated to see just $1 million in sequential growth in Q2 before a (6%) sequential decline in Q3.
On an annual view, revenue growth for the two is expected to slow dramatically in FY25 and FY26. Robinhood is estimated to report more than 28% revenue growth this year, but in 2025, growth is expected to decelerate 23 percentage points to just 5.3%. Coinbase’s revenue deceleration is much more severe, with estimated revenue growth of 81.1% in 2024 projected to decelerate to below 1% growth in 2025.
Source: I/O Fund
This rapid revenue deceleration to the single-digits is expected to persist, with Robinhood forecast to see just 3% revenue growth in 2026, while Coinbase’s revenue is expected to decline more than (2%) YoY, pointing to a revenue plateau in the $5.5 to $5.6 billion range.
Technical Analysis:
Coinbase (COIN)
COIN is in an uptrend that appears to be incomplete. It has been tied to Bitcoin’s uptrend, which is even more clearly incomplete. This means that COIN could be setting up for a buying opportunity on the next drop.
The larger pattern in play is a diagonal. This is a 5 wave pattern that is characterized by lots of overlap, big swings in both directions, and tends to obey a trend channel. If this is playing out, then Coin base is setting up for a sharp drop into the $185 – $140 region. This drop will be the final swing lower, which will complete wave 4 of 5. We can see a drop as low as $113 and still maintain the diagonal pattern; however, below this level and the odds start favoring that a major top was already struck in March of this year.
If we are accurate, like Bitcoin, this dip would be another buying opportunity in an on-going uptrend. The final 5th wave would be generally targeting the $300 – $400 region, if confirmed. This is assuming we hold $113.
Source: I/O Fund
Robinhood (HOOD)
HOOD’s chart is not in a healthy position. Note the drop from all-time-highs. This is a direct drop that best resembles a 5 wave pattern. What has followed is an overlapping and messy bounce, which resembles a correction within a larger trend. If this is a developing downtrend, then the initial 5 wave drop is the A wave, the messy bounce is the B wave, which is setting up for a C wave drop, which I would expect to be about the same length as the A wave drop.
The final move higher is also quite telling. The last leg of a corrective bounce is always a 5 wave push against the larger trend. You can clearly see 5 waves in place, which takes us into the ideal topping zone for this move. In order for HOOD to start invalidating this setup, we really need to see a strong move above $48.10.
On the other hand, if HOOD is in the larger downtrend pattern, then the final leg lower will be a C wave. These are always 5 wave patterns, which appears to be vertical moves. If we see a vertical, 5 wave drop from any high, followed by a messy bounce in the opposite direction, we will have strong confirmation that HOOD is setting up for a larger drop.
This is not one we would play from the long side based on what the technical are telling us.
Source: I/O Fund
Conclusion:
Coinbase and Robinhood capitalized on increased crypto volatility in Q1 as crypto prices rose following the approval of spot BTC ETFs in January. Trading volume and transaction revenue growth was stellar for both in the first quarter, but Robinhood’s monthly metrics reflect weak MoM growth through Q2 so far, as Dogecoin volume and volatility subsides.
Robinhood is overdependent on Dogecoin as a primary driver of crypto trading volume and thus crypto transaction revenue, and with crypto accounting for 20% of overall revenue, it’s not something to ignore. Robinhood’s exposure to Dogecoin is unusual, and also a risk most investors probably aren’t aware of. When you couple these fundamental headwinds with the troubling chart, it seems there could be more trouble for HOOD on the horizon. This is not a stock we would play on the long side.
As Bitcoin continues to play out the ongoing bull cycle, we expect COIN to follow. The next high discussed in this writeup is where we will start getting cautious with both Bitcoin and COIN, as both charts suggest an incomplete uptrend. That being said, this drop in COIN appears to be a buying opportunity, as long as the critical support holds that we discussed.
I/O Fund Portfolio Manager Knox Ridley and I/O Fund Equity Analyst Damien Robbins contributed to this analysis.
Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund own BTC at the time of writing and may own stocks pictured in the charts.
Broadcom will release its results today. Investors will be closely watching the AI revenue updates. During its last earnings call, the company raised the AI revenue guide to $10 billion for FY2024 from the earlier $7.5 billion. In Q1 earnings, the stronger-than-expected growth from AI offset the cyclical weakness in broadband and server storage.
During its AI Infrastructure Investor meeting held in March, the company announced its third AI ASIC customer. We are likely to get more updates in the earnings call. In addition to the AI revenue, the software segment is also to be watched as the company integrates VMware into its fold.
Revenue
The analysts expect Q2 FY2024 revenue to grow 37.5% YoY to $12.01 billion and accelerate to 42.8% and 48.1% in the next two quarters. The company’s Q1 revenue grew by 34.2% YoY to $11.96 billion. Excluding the 10.5 weeks of contribution from VMware, it grew 11% and a 7-point acceleration from the previous quarter. To recap, the company completed its acquisition of VMware in November 2023 and the management’s FY 2024 guide of $50 billion includes VMware’s 11-month contribution of $12 billion.
Margins
The merger integration process is expected to take a year and will initially have a drag on profit margins due to transition costs and VMware's lower margin profile. However, cost-cutting measures and merger synergies are anticipated to improve margins in the long term.
Q1 gross margin was 61.7% compared to 67.4% in the year-ago quarter. Amortization of acquisition-related intangible assets adversely impacted gross margin by 11.5% in the quarter compared to 6.0% in the year-ago quarter. Adjusted gross margin improved 160 bps YoY to 75.4%.
Q1 operating margin was 17.4% compared to 46% in the year ago quarter. The operating margin was mainly lower due to the increase of amortization of acquisition-related intangible assets, restructuring charges, and stock-based compensation. The adjusted operating margin was 57.1%, compared to 60.9% in the year ago quarter.
Q1 net margin was 11.1% compared to 42.3% in the year-ago quarter. The net margin was lower mainly due to points discussed in the above paragraphs. The adjusted net margin was 43.9%, compared to 50.3% in the year-ago quarter. The adjusted EPS grew by 6.4% YoY to $10.99 and beat estimates by 5.4%.
The analysts expect adjusted EPS to grow 5.1% YoY to $10.84 in Q2 FY2024 and accelerate to 13% and 21.9% growth in the next two quarters.
Q1 FY2024 adjusted EBITDA margin was 59.8% compared to 63.7% in the year-ago quarter. The management reiterated its fiscal year revenue guide of $50 billion and full year adjusted EBITDA guidance of 60%. The margin drop is mainly due to VMware's lower margin. However, Broadcom aims to improve the margins through cost-cutting initiatives like job cuts and merger synergies.
Cash Flow and Balance Sheet
Q1 operating cash flows were $4.8 billion or 40.3% of revenue compared to $4.04 billion or 45.3% in the year-ago quarter. Free cash flows were $4.69 billion or 39.2% of revenue compared to $3.93 billion or 44.1%. Excluding the restructuring and integration spend of $658 million in the quarter, the free cash flow was 45% of revenue.
Cash was $11.9 billion and debt was $75.9 billion. The debt increased from the $39.2 billion in the previous quarter due to the additional debt taken to finance the VMware purchase and the company also assumed $8.3 billion VMware’s debt.
The average coupon rate and years to maturity of fixed rate debt of $48 billion is 3.5% and 8.4 years, respectively. The average coupon rate and years to maturity of floating rate debt of $30 billion is 6.6% and 3 years, respectively. The company repaid $934 million fixed rate debt during the quarter. The company also repaid $2 billion of floating rate debt during the first week of March (the week the Q1 results were announced) and intends to maintain the $2 billion quarterly repayment of debt throughout FY2024.
In Q1, Broadcom paid stockholders $2.4 billion of cash dividends based on a quarterly common dividend of $5.25 per share. The company repurchased $7.2 billion of common stock and eliminated $1.1 billion of common stock for taxes due on the vesting of employee equity, resulting in the repurchase and elimination of approximately 7.7 million shares.
Days sales outstanding were 41 days in the first quarter compared to 31 days in the fourth quarter on higher accounts receivable due to the VMware acquisition. This is due to the accounts receivable from VMware having payment terms of 60 days compared to Broadcom’s 30 days.
The company ended the first quarter with an inventory of $1.9 billion, up 1% sequentially.
Segments
Infrastructure Software
Infrastructure Software segment revenue grew by 153% YoY to $4.6 billion. If we exclude a $2.1 billion contribution from VMware the segment grew by 37% YoY and accelerated from 7% growth in the previous quarter. When asked about this, management said not to get too excited about this particular growth as it’s due to strong contract renewals. Instead, the CEO explicitly stated: “Yes, don't get too excited over that. So that has also accelerated, but that's not the star of this show, Stacy. Star this show is the accelerating bookings and backlog we are accumulating on VMware.” In fact, it was indicated that some of this could fall off in future quarters given the software guide was not raised.
What the CEO is referring to as the star of the show is the consolidated bookings in software, which grew sequentially from less than $600 million to $1.8 billion in Q1 and is expected to grow to over $3 billion in Q2. Per management: “Revenue from VMware will grow double-digit percentage. Sequentially, quarter-over-quarter, through the rest of the fiscal year.” Management reiterated their software revenue guidance of $20 billion for this year.
Semiconductor solutions
Semiconductor solutions sales increased 4% YoY to $7.4 billion, up from 3% growth in the prior quarter. Stronger-than-expected growth from AI more than offsetting the cyclical weakness in broadband and server storage. AI revenue grew by 53% sequentially to $2.3 billion.
Q1 networking revenue of $3.3 billion grew 46% year-on-year, primarily helped by the strong demand for custom AI accelerators from the company’s two hyperscale customers. The networking revenue represented 45% of semiconductor revenue and accelerated from 23% growth in the previous quarter. Management stated, “For fiscal 2024, given continued strength of AI NAND working demand, we now expect networking revenue to grow over 35% year-on-year compared to our prior guidance for 30% annual growth.”
Q1 wireless revenue declined by (-4%) YoY to $2.0 billion. Wireless is expected to be flat YoY for FY2024.
Q1 server storage revenue declined by (-29%) YoY to $887 million. Management expects weaker demand in the first half of the year and recovery in the second half. Management revised its server storage revenue to decline in the mid-20 percentage range compared to prior guidance for a decline in the high teens.
Q1 broadband revenue declined by (-23%) YoY to $940 million. Management stated, “We are seeing a cyclical trough this year for broadband as telco spending continues to weaken and do not expect improvement until late in the year.” So, they revised the outlook for fiscal '24 broadband revenue to be down 30% year-on-year from prior guidance of down mid-teens year-on-year.
Q1 industrial resales of $215 million declined by (-6%) YoY. Management stated that industrial resales will be down by high single digits this year.
AI revenue
Management also reiterated the guidance for FY2024 for Semiconductor Solutions revenue to grow mid-to high single-digit percentage year-on-year. They also increased the AI revenue guide to $10 billion from the earlier $7.5 billion and now expects AI revenue to be 35% of the semiconductor revenue from the previous 25%.
During its AI Infrastructure Investor meeting held in March, the company announced its third AI ASIC customer. Charlie Kawwas, Broadcom's President, Semiconductor Solutions Group, said, “Well, since you're all here today and you traveled here, we wanted to actually share with you that we actually have a third customer. I don't hear any excitement. Come on. So we're very, very honored and pleased and happy to tell you that third customer is also in the consumer AI space and we are in the ramp phase and we will be shipping products in the next few months to that customer. And this is something that we believe will continue as well over the next few years.”
This is certainly big since the CEO mentioned, “it takes years. It takes a lot of heavy lifting to create that custom silicon because you need to do more than just hardware of silicon to really have a solution for generative…” The company counts Google and Meta as the first two customers and JP Morgan believes that the third could be ByteDance. They also believe that the company has recently won follow-on orders from Google and Meta.
"Overall, we estimate that Google and Meta combined will drive $9B+ in AI ASIC chip revenues for Broadcom this year (Google ~$8B+ and Meta around $500M-$1B), up almost 2.5x over CY23," wrotetheanalyst. "More importantly, as we said back in 2022, we believe that Meta remains on track to become Broadcom's next multi-billion dollar per year AI ASIC customer potentially starting in CY25." JP Morgan estimates that the AI revenue to be $10 billion to $12 billion for FY2024, driven by the third customer, strong demand for Tomahawk 5 and Jericho 3 switching/routing chipsets and PCIe Gen5/Gen6 switches.
Valuation
We understand the market expectations are high going into earnings. The company is trading at a P/E ratio of 52.1 and P/S ratio of 15.8, higher than the five-year average P/E ratio of 39.4 and P/S ratio of 8.1.
Conclusion
The continued strong AI revenue growth along with the addition of the recent AI ASIC customer is a bright spot offsetting the weakness in broadband and server storage. The synergies from the VMware acquisition are another key area to watch going forward.
Pro premium members receive deep-dive research on all the stocks in the portfolio and quarterly earnings kickoff webinars. In addition, the Advanced Market Signals Members receive regular technical and broad market analysis and weekly webinars from our Portfolio Manager, Knox Ridley. We closed Super Micro in early May for an average gain of 275% across all entries and exits. Also, we booked sizable gains in two cybersecurity stocks in April. Learn more here.We closed Super Micro in early May for an average gain of 275% across all entries and exits. Also, we booked sizable gains in two cybersecurity stocks in April. Learn more here.
Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.
Broadcom will release its results today. Investors will be closely watching the AI revenue updates. During its last earnings call, the company raised the AI revenue guide to $10 billion for FY2024 from the earlier $7.5 billion. In Q1 earnings, the stronger-than-expected growth from AI offset the cyclical weakness in broadband and server storage.
During its AI Infrastructure Investor meeting held in March, the company announced its third AI ASIC customer. We are likely to get more updates in the earnings call. In addition to the AI revenue, the software segment is also to be watched as the company integrates VMware into its fold.
Revenue
The analysts expect Q2 FY2024 revenue to grow 37.5% YoY to $12.01 billion and accelerate to 42.8% and 48.1% in the next two quarters. The company’s Q1 revenue grew by 34.2% YoY to $11.96 billion. Excluding the 10.5 weeks of contribution from VMware, it grew 11% and a 7-point acceleration from the previous quarter. To recap, the company completed its acquisition of VMware in November 2023 and the management’s FY 2024 guide of $50 billion includes VMware’s 11-month contribution of $12 billion.
Margins
The merger integration process is expected to take a year and will initially have a drag on profit margins due to transition costs and VMware's lower margin profile. However, cost-cutting measures and merger synergies are anticipated to improve margins in the long term.
Q1 gross margin was 61.7% compared to 67.4% in the year-ago quarter. Amortization of acquisition-related intangible assets adversely impacted gross margin by 11.5% in the quarter compared to 6.0% in the year-ago quarter. Adjusted gross margin improved 160 bps YoY to 75.4%.
Q1 operating margin was 17.4% compared to 46% in the year ago quarter. The operating margin was mainly lower due to the increase of amortization of acquisition-related intangible assets, restructuring charges, and stock-based compensation. The adjusted operating margin was 57.1%, compared to 60.9% in the year ago quarter.
Q1 net margin was 11.1% compared to 42.3% in the year-ago quarter. The net margin was lower mainly due to points discussed in the above paragraphs. The adjusted net margin was 43.9%, compared to 50.3% in the year-ago quarter. The adjusted EPS grew by 6.4% YoY to $10.99 and beat estimates by 5.4%.
The analysts expect adjusted EPS to grow 5.1% YoY to $10.84 in Q2 FY2024 and accelerate to 13% and 21.9% growth in the next two quarters.
Q1 FY2024 adjusted EBITDA margin was 59.8% compared to 63.7% in the year-ago quarter. The management reiterated its fiscal year revenue guide of $50 billion and full year adjusted EBITDA guidance of 60%. The margin drop is mainly due to VMware's lower margin. However, Broadcom aims to improve the margins through cost-cutting initiatives like job cuts and merger synergies.
Cash Flow and Balance Sheet
Q1 operating cash flows were $4.8 billion or 40.3% of revenue compared to $4.04 billion or 45.3% in the year-ago quarter. Free cash flows were $4.69 billion or 39.2% of revenue compared to $3.93 billion or 44.1%. Excluding the restructuring and integration spend of $658 million in the quarter, the free cash flow was 45% of revenue.
Cash was $11.9 billion and debt was $75.9 billion. The debt increased from the $39.2 billion in the previous quarter due to the additional debt taken to finance the VMware purchase and the company also assumed $8.3 billion VMware’s debt. We discussed this in our deep dive here.
The average coupon rate and years to maturity of fixed rate debt of $48 billion is 3.5% and 8.4 years, respectively. The average coupon rate and years to maturity of floating rate debt of $30 billion is 6.6% and 3 years, respectively. The company repaid $934 million fixed rate debt during the quarter. The company also repaid $2 billion of floating rate debt during the first week of March (the week the Q1 results were announced) and intends to maintain the $2 billion quarterly repayment of debt throughout FY2024.
In Q1, Broadcom paid stockholders $2.4 billion of cash dividends based on a quarterly common dividend of $5.25 per share. The company repurchased $7.2 billion of common stock and eliminated $1.1 billion of common stock for taxes due on the vesting of employee equity, resulting in the repurchase and elimination of approximately 7.7 million shares.
Days sales outstanding were 41 days in the first quarter compared to 31 days in the fourth quarter on higher accounts receivable due to the VMware acquisition. This is due to the accounts receivable from VMware having payment terms of 60 days compared to Broadcom’s 30 days.
The company ended the first quarter with an inventory of $1.9 billion, up 1% sequentially.
Segments
Infrastructure Software
Infrastructure Software segment revenue grew by 153% YoY to $4.6 billion. If we exclude a $2.1 billion contribution from VMware the segment grew by 37% YoY and accelerated from 7% growth in the previous quarter. When asked about this, management said not to get too excited about this particular growth as it’s due to strong contract renewals. Instead, the CEO explicitly stated: “Yes, don't get too excited over that. So that has also accelerated, but that's not the star of this show, Stacy. Star this show is the accelerating bookings and backlog we are accumulating on VMware.” In fact, it was indicated that some of this could fall off in future quarters given the software guide was not raised.
What the CEO is referring to as the star of the show is the consolidated bookings in software, which grew sequentially from less than $600 million to $1.8 billion in Q1 and is expected to grow to over $3 billion in Q2. Per management: “Revenue from VMware will grow double-digit percentage. Sequentially, quarter-over-quarter, through the rest of the fiscal year.” Management reiterated their software revenue guidance of $20 billion for this year.
Semiconductor solutions
Semiconductor solutions sales increased 4% YoY to $7.4 billion, up from 3% growth in the prior quarter. Stronger-than-expected growth from AI more than offsetting the cyclical weakness in broadband and server storage. AI revenue grew by 53% sequentially to $2.3 billion.
Q1 networking revenue of $3.3 billion grew 46% year-on-year, primarily helped by the strong demand for custom AI accelerators from the company’s two hyperscale customers. The networking revenue represented 45% of semiconductor revenue and accelerated from 23% growth in the previous quarter. Management stated, “For fiscal 2024, given continued strength of AI NAND working demand, we now expect networking revenue to grow over 35% year-on-year compared to our prior guidance for 30% annual growth.”
Q1 wireless revenue declined by (-4%) YoY to $2.0 billion. Wireless is expected to be flat YoY for FY2024.
Q1 server storage revenue declined by (-29%) YoY to $887 million. Management expects weaker demand in the first half of the year and recovery in the second half. Management revised its server storage revenue to decline in the mid-20 percentage range compared to prior guidance for a decline in the high teens.
Q1 broadband revenue declined by (-23%) YoY to $940 million. Management stated, “We are seeing a cyclical trough this year for broadband as telco spending continues to weaken and do not expect improvement until late in the year.” So, they revised the outlook for fiscal '24 broadband revenue to be down 30% year-on-year from prior guidance of down mid-teens year-on-year.
Q1 industrial resales of $215 million declined by (-6%) YoY. Management stated that industrial resales will be down by high single digits this year.
AI revenue
Management also reiterated the guidance for FY2024 for Semiconductor Solutions revenue to grow mid-to high single-digit percentage year-on-year. They also increased the AI revenue guide to $10 billion from the earlier $7.5 billion and now expects AI revenue to be 35% of the semiconductor revenue from the previous 25%.
During its AI Infrastructure Investor meeting held in March, the company announced its third AI ASIC customer. Charlie Kawwas, Broadcom's President, Semiconductor Solutions Group, said, “Well, since you're all here today and you traveled here, we wanted to actually share with you that we actually have a third customer. I don't hear any excitement. Come on. So we're very, very honored and pleased and happy to tell you that third customer is also in the consumer AI space and we are in the ramp phase and we will be shipping products in the next few months to that customer. And this is something that we believe will continue as well over the next few years.”
This is certainly big since the CEO mentioned, “it takes years. It takes a lot of heavy lifting to create that custom silicon because you need to do more than just hardware of silicon to really have a solution for generative…” The company counts Google and Meta as the first two customers and JP Morgan believes that the third could be ByteDance. They also believe that the company has recently won follow-on orders from Google and Meta.
"Overall, we estimate that Google and Meta combined will drive $9B+ in AI ASIC chip revenues for Broadcom this year (Google ~$8B+ and Meta around $500M-$1B), up almost 2.5x over CY23," wrotetheanalyst. "More importantly, as we said back in 2022, we believe that Meta remains on track to become Broadcom's next multi-billion dollar per year AI ASIC customer potentially starting in CY25." JP Morgan estimates that the AI revenue to be $10 billion to $12 billion for FY2024, driven by the third customer, strong demand for Tomahawk 5 and Jericho 3 switching/routing chipsets and PCIe Gen5/Gen6 switches.
Valuation
We understand the market expectations are high going into earnings. The company is trading at a P/E ratio of 52.1 and P/S ratio of 15.8, higher than the five-year average P/E ratio of 39.4 and P/S ratio of 8.1.
Conclusion
The continued strong AI revenue growth along with the addition of the recent AI ASIC customer is a bright spot offsetting the weakness in broadband and server storage. The synergies from the VMware acquisition are another key area to watch going forward.
