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," wrote the analyst. "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.

Recommended Readings:

Broadcom: $10B in AI Revenue This Year Plus Software is Rapidly AcceleratingBroadcom: $10B in AI Revenue This Year Plus Software is Rapidly Accelerating

Broadcom: Networking/ASICs Giant and The Second Largest by AI RevenueBroadcom: Networking/ASICs Giant and The Second Largest by AI Revenue

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