Marvell Q3: AI-Driven Rebound on the Books, Bottom Line in Focus

Posted on by io-fund

We encourage you to read our previous post-ER write-up found here and also the pre-ER found here as it goes through the pros/cons of Marvell’s fundamental profile, and our motivation in adding the stock back to our portfolio.

Per our last write-up, the bull case is this:

“Marvell doubled its AI revenue from $400 million to $800 million. This means AI is now 14.4% of revenue, up from roughly 7% (on an annual run rate). This is bullish for our CY2024 thesis, and was not expected so soon. The most important statement on the call was this: 

“Based on our latest demand outlook for our electro-optics products, we now expect revenue from AI to exit this year at over a $200 million quarterly revenue run rate or $800 million annualized. This is well above what we had outlined last quarter. Put this in perspective, this would put us at the run rate we had previously communicated for all of next year.”

However, the bottom line is in bad shape as it’s not an ideal time to have to access the debt capital markets. Per our last write-up:

“Where the report is concerning is the increasing net debt to EBITDA ratio, which has increased from 1.6X to 1.8X. You can expect us to risk manage this position depending on FED actions. It was stated in the call: “we will opportunistically explore accessing the debt capital markets to refinance our upcoming debt maturities.”

This is an important quarter for Marvell to step up and improve its bottom line as the market has overlooked this given the AI story is quite strong. The ingredients are there as revenue and EPS is expected to nicely rebound over the next few quarters, it’ll be up to management to prove they can give the market what it wants in terms of profits and cash flow margin.

Revenue and EPS

  • Q2 revenue declined by (-11.6%) YoY to $1.341 billion
  • Management Q3 revenue guidance and consensus is $1.4 billion, representing a YoY decline of (8.9%) at the mid-point. It’s expected that the revenue YoY decline will bottom in Q3 and a return to growth is expected in Q4.
  • GAAP EPS was (-$0.24) last quarter and is expected to be ($-0.07) +/- $0.05 this quarter. The negative to thin profit margin is one of the primary concerns with Marvell.
  • Last quarter, adjusted EPS was $0.33. Management’s Q3 guidance ranges from $0.35 to $0.45, mid-point of $0.40. This represents a YoY decline of (29.7%). The YoY decline in earnings will also bottom out in Q3 with a return to growth expected in Q4.

Margins

  • Management guidance for Q3 gross margin is 46.8%. Adjusted gross margin guidance is 60.8%. It was stated that adj. gross margin will reach 64% in Q4 helped by a recovery in data center storage. The gross margin is also expected to benefit from cost cutting initiatives like optimizing headcount and continuing to partner with the suppliers to drive more efficiency in the supply chain.

o   The Q2 gross margin was 38.9% compared to 42.2% in Q1 and 51.8% in the same period last year. The gross margin was down due to lower percentage of data center revenues in the revenue mix.

  • Management has guided for GAAP operating margin of (-1%) compared to (-15.3%) in the previous quarter. Management guidance on adjusted operating margin is 29.6% compared to 25.2% in Q1. 
  • The adjusted net margin improved 164 basis points sequentially to 21.64% and was down from 32% in the same period last year.

Cash Flow and Balance Sheet 

The operating cash flow margin was 8.4% compared to 15.8% in Q1 and 21.8% in the same period last year.  The operating cash flow margin was low primarily due to an increase in DSO (days sales outstanding) and severance-related cash restructuring charges. Management mentioned that they expect DSO to improve in the next quarter.

The CFO, Willem Meintjes, replied to an analyst’s question.

“Yes, so this quarter certainly DSO was impacted somewhat by linearity. We do expect a nice back — bounce-back in Q3 and some normalization.”

It is crucial for the company to improves its cash flows in the coming quarter. The free cash flow dropped to $1.2 million compared to $105.8 million in Q1 and $256.3 million in the same period last year. The lower operating cash flows and higher capex of $111 million led to the drop in the free cash flow.

The company has cash of $423.4 million compared to $1.03 billion at the end of Q1. Debt is $4.15 billion, which includes short-term debt of $1.02 billion. The company used $572 million to repay debt in the recent quarter. Due to the lower cash flows, the company had to repay its debt entirely from the cash balance. This was contrary to what management had indicated in the Q1 earnings call when they stated they would repay debt from free cash flow and cash balance.

They have resumed buybacks as indicated in the last earnings call and it doesn’t seem ideal the company would take this route when the net debt to EBITDA ratio has increased from 1.6x in Q1 to 1.83 in Q2. Per the earnings call, “we will opportunistically explore accessing the debt capital markets to refinance our upcoming debt maturities.”

This is our primary concern with Marvell in the near term given elevated interest rates.

Key Metrics

Data center revenue was down (-29%) and was up 6% QoQ to $459.8 million, which should be marking a bottom, as long as storage recovery doesn’t get pushed out further. This exceeded guidance of 0% QoQ growth. The beat was due to the AI networking products. We’ve covered additional datapoints on the storage recovery and memory rebound here. This compares to being down (-32%) YoY last quarter and (-12%) QoQ decline.

On a QoQ basis, data center is expected to accelerate to “mid-teens” growth. Per management: “Demand for our AI products continues to grow at an extraordinary rate and we are working very closely with our customers to meet rapidly evolving needs. On the other hand, enterprise on-premise is expected to continue to trend down. As a result, we are projecting overall data center revenue in the third quarter to grow in the mid-teens sequentially on a percentage basis.”

Carrier infrastructure end market was down (-3%) YoY and down (-5%) QoQ to $275.5 million due to wired networks whereas 5G was strong at 25% QoQ growth. The carrier end market is expected to grow in low single digit sequentially helped by wireless.

Enterprise networking declined (-4%) YoY and (-10%) QoQ to $327.7 million. This is expected to decline further into the low teens QoQ next quarter. Per management, enterprise networking will take a few quarters to normalize: “We expect this inventory re-normalization to take a few quarters to resolve as customer balance sheets get worked down over time.”

Consumer end market is up 2% YoY and up 18% QoQ to $167.7 million. Revenue is expected to grow sequentially in the low teens next quarter.

Automotive and industrial end market was up 32% YoY and 23% QoQ to $110.2 million driven by increased adoption of Ethernet in cars. This segment is expected to be up 30% YoY and flat sequentially.

Conclusion:

We are watching tonight’s report with anticipation as we hope to see the product story overcome the challenges seen in the bottom line, — if not this quarter than at least in the company’s guidance for next quarter. There is an incoming, material rebound, as detailed above. What we want to see is if the rebound is strong enough to result in a decent cash margin and GAAP profits. If so, we will have a win-win to where the fundamentals are improving and a nice product story is setting up for 2024. If not, we will go back to the drawing board to figure out how to risk manage in a way that instills persistence for the longer-term thesis.

Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.

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