Category: AI Stocks

Taiwan Semiconductor Stock: April Sales Soar From Advanced Nodes

Posted on by io-fund

This article was originally published on Forbes on ForbesForbes on May 30, 2024,03:26pm EDT

Taiwan Semiconductor (TSMC) is the supplier for major design companies, such as Apple, Nvidia, AMD, Arm, Qualcomm, Broadcom, MediaTek and Marvell. TSMC is a foundry that manufactures the world’s most advanced chips, designated by node size. The most advanced node in production today is the 3nm and is primarily used by Apple in iPhones and MacBooks. The 5nm/4nm is used by Nvidia and others for AI accelerators, with high-performance computing quickly moving to 3nm and even 2nm.

Taiwan Semiconductor reported earnings on April 18th. The company topped analyst estimates and its internal guide with revenue growth of 12.9% YoY growth for US$18.9 billion. EPS beat by 4.5% at $1.38 reported compared to $1.32 expected.

Advanced node revenue continues to remain strong, though 3nm revenue dipped sequentially. Per the opening remarks: “3-nanometer process technology contributed 9% of wafer revenue in the first quarter.” This is down from 15% last quarter. The decline is temporary with Trend Force expecting 3nm production capacity utilization to be up 80% by year end. This quarter, revenue from 5nm and 7nm both expanded 2 points.

Despite warning of a slowdown in the broader semiconductor industry this year, TSMC’s April sales surged 60% YoY and 21% MoM. This marks a positive start to the 20-percentage point acceleration to 33% revenue growth that analysts expect as soon as the September quarter.

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Background on Advanced Nodes: 5nm, 3nm and upcoming 2nm

Currently, AI accelerators use TSMC’s 5nm process. Nvidia’s Hopper and Blackwell are built with a N4X process that is tailored for high-performance computer applications. This is a customized variant called “4N” that Nvidia uses, yet TSMC recognizes this as 5nm revenue in their earnings report. AI accelerators are expected to quickly move to smaller nodes to help lower power consumption. TSMC’s 3nm process is more energy efficient, and energy efficiency will improve further with the 2nm process.

3nm (N3) and 2nm (N2) technology:

The 3nm process is currently the most advanced semiconductor technology, representing a full node advance from the 5nm generation. 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.

In 2023, TSMC made 3nm chips for Apple’s iPhone 15 Pro, iPhone 15 Pro Max and MacBook’s M3 chips. In 2024, TSMC will expand its 3nm customers to include AMD and Intel. What is interesting is that Nvidia is not using the 3nm node in 2024, despite industry-wide expectations Blackwell would feature the most advanced node. Instead, Blackwell is relying on architecture for its advancement leap from the Hopper architecture.

TSMC offers enhanced 3nm processes, such as the N3E, N3P and N3X, which allows a company like Apple to customize the 3nm chips differently than those for hyperscalers. 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 very high performance but with up to 250% power leakage.

The 3nm marks the end of FinFET transistors, which stands for field-effect transistor. With FinFET, the gate is wrapped on three sides, whereas with gate-all-around (GAA), as the name implies, the gate is wrapped around on all sides. FinFET is used in 14nm, 10nm and 7nm nodes. TSMC uses FinFETs in the 5nm, yet will phase out FinFET after the 3nm. As TSMC moves toward GAA for the 2nm, having the gate wrap “all-around” will create a greater surface area for better electrostatic control and to also reduce leakage.

Regarding FinFET, the FinFlex technology unique to TSMC allows for chip designers to customize the number of fins per transistor. There are three configurations that balance performance with power consumption. Hybrid CPUs use FinFlex where high-performance cores are matched with power efficient cores, with the ability to activate whichever cores are needed most depending on the workload. The end result is that chip designers can have control over the configuration.

2nm: Nanosheet Transistors and Backside Power Delivery

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%.

For TSMC, the 2nm will feature NanoFlex technology, which is similar to FinFlex to where designers can use cells from different libraries. However, due to the new gate-all-around (GAA) nanosheet transistors, there are additional benefits, such as customizing the width and height of cells.

Intel’s 20A will be the first to feature backside power delivery for faster switching and to alleviate routing congestion. With this release, Intel is introducing the “angstrom” era” which translates to future process generations where the process nodes are not smaller necessarily, rather the transistors they’re built with will be improved upon. For Intel, instead of the GAAFET, the company is introducing RibbonFET transistors where multiple flat nanosheets are stacked to enable better current flow.

In the future, we will dive deeper for our free newsletter subscribers into the fierce competition that is heating up between TSMC and Intel at the foundry level. For now, the main points are that TSMC’s N3 will rely on FinFET with GAAFET being introduced for N2. The expectations is that N2 will be available by the second half of 2025. Intel is emerging as a more capable competitor to TSMC with the 20A featuring RibbonFET gate-all-around and backside power delivery, due late 2024-early 2025.

Here is what TSMC’s management has stated about the competition, which communicates that TSMC is not sweating Intel right now:

"In fact, let me repeat again, our 2nm technology without backside power (N2) is more advanced than both N3P and 18A, and will be the semiconductor industry's most advanced technology when it is introduced in 2025."

In terms of timing, management recently offered the following: “Randy, the N2's ramp profile we say is very similar to N3 because of, look at the cycle time, we start the N2 production in the second half of 2025, actually in the last quarter of 2025. And because of the cycle time and all the kind of back-end process, and so we expect the meaningful revenue will start from the end of the first quarter or beginning of the second quarter of 2026.”so we expect the meaningful revenue will start from the end of the first quarter or beginning of the second quarter of 2026.”

Advanced Nodes Contribute 65% of Revenue in Q1

TSMC’s advanced nodes (3nm to 7nm) contributed 65% of revenue in Q1, up from 51% last year. This was driven primarily by the 5nm node, at 37% of revenue, as well as the continual ramp of the 3nm node, although 3nm revenues dipped quite heavily QoQ.

TSMC Revenue per Node

Source: I/O Fund

Revenue contribution from TSMC’s most advanced 3nm node dropped QoQ from 15% to 9% in Q1. Revenues fell nearly 40% QoQ from $2.9B to $1.7B in the most recent quarter. This is not necessarily unusual in the early ramp stages, given that the 5nm node saw a similar pattern in Q4 2020 and Q1 2021, where revenue contribution dipped before accelerating for multiple quarters. There is indication that TSMC will have to allocate more resources to 3nm, and this will come from 5nm fabrication equipment. Therefore, it may be in 2025 that we see 3nm exceed 20% percentage of revenue, which was forecast by management in a previous earnings call.

“We can convert one technology node capacity to the next one is because of our GI's physical advantage, meaning, let me give you one example, our 3-nanometer and 5-nanometer are adjacent to each other, the fabs, and they are all connected. So it's much easier for TSMC to convert from 5 to 3. And that doesn't mean that every node can do the same.”“We can convert one technology node capacity to the next one is because of our GI's physical advantage, meaning, let me give you one example, our 3-nanometer and 5-nanometer are adjacent to each other, the fabs, and they are all connected. So it's much easier for TSMC to convert from 5 to 3. And that doesn't mean that every node can do the same.”

In dollar terms, advanced nodes notched their two best quarters in Q4 and Q1, generating $13.2 billion and $12.3 billion, respectively. Q1’s soft 3nm sales were offset by sequential dollar gains in 5nm and 7nm, with advanced node revenue falling just 6.8% QoQ.

CEO C.C. Wei clarified in the earnings call that most of the current AI accelerators on the market “are in the 5- or 4-nanometer technology,” hence why we’re seeing strong 5nm sales and sequential growth in a seasonally slower quarter.

Advanced Node Revenue

Source: I/O Fund

Despite most AI accelerators currently being produced on a 5nm node or 4NP node, including Nvidia’s upcoming Blackwell lineup, TSMC sees a clear path to increasing the 3nm node’s revenue contribution through the rest of the year. This will include converting 5nm node tools to support 3nm capacity and demand. Some of the capacity constraints are coming from HBM3e and the surge in CoWoS advanced packaging, which we’ve covered in more detail in our analysis: “Nvidia Q1 Earnings Preview: Blackwell and the $200 Billion Data Center.”

While 3nm’s ramp so far has been strong, management has been dropping hints that customer adoption on its upcoming 2nm node, set for production by year end 2025, will be even strongerwill be even stronger.

On the most recent earnings call, it was stated: “observing a high level of customer interest and engagement at N2 and expect the number of the new tape-outs from 2-nanometer technology in its first 2 years to be higher than both 3-nanometer and 5-nanometer in their first 2 years.”

Margins Guided Sequentially Weaker

Despite strong HPC growth, bucking what’s normally a seasonal decline in Q1 to report sequential growth, margins face some headwinds through the rest of the year.

TSMC reported a 53.1% gross margin in Q1 and a 42% operating margin. For Q2, TSMC guided for a lower gross margin of 51% to 53%, primarily impacted by the recent 25% electricity price hike in Taiwan, some impacts from the earthquake, and 3nm’s ramp with the 3nm not at corporate gross margins yet. Operating margin was guided to be 40% to 42%, pointing to a slight 1-point QoQ decline, at midpoint.

Here’s what management said about Q2’s guide and some lasting headwinds through the rest of the year:

“After last year's 17% electricity price increase from April 1, TSMC's electricity price in Taiwan [has] increased by another 25% starting April 1 this year. This is expected to take out 70 to 80 basis points from our second quarter gross margin. Looking ahead to the second half of the year, we expect the impact from higher electricity costs continue and dilute our gross margin by 60 to 70 basis points […]

In addition, we expect our overall business in the second half of the year to be stronger than the first half. And revenue contribution from 3-nanometer technologies is expected to increase as well, which will dilute our gross margin by 3 to 4 percentage points in second half '24 as compared to 2 to 3 percentage points in first half of '24.

Finally, as we have said before, we have a strategy to convert some 5-nanometer tools to support 3-nanometer capacity given the strong multiyear demand. We expect this conversion to dilute our gross margin by about 1 to 2 percentage points in the second half of 2024.”

Overall, the largest headwinds to gross margin stem from ramping the 3nm node, which is to be expected, given TSMC has historically seen 3 to 5 percentage point headwinds in the initial (3-4 quarters) ramp phase before ultimately realizing higher margins once the node has scaled. This has occurred with both the 7nm and 5nm node.

AI-Related Revenue Reaches Fresh Record, Driving Strong Outlook

As the leading foundry for AI accelerators, TSMC is riding the enormous wave of demand from Big Tech. The chipmaker’s high-performance computing (HPC) revenues rose 3% QoQ to ~$8.68 billion, a fresh record despite the first quarter typically being seasonally weaker. HPC revenues (which are AI-related) increased 18% YoY as well.

HPC Revenue

Source: I/O Fund

Q2 is already off to a strong start. TSMC’s April sales rose nearly 60% YoY and 21% MoM to NT$236.02 billion, or US$7.28 to 7.30 billion.

TSMC had guided revenue for Q2 between $19.6 billion and $20.4 billion, and April’s surge puts it on track to land in the upper half of or above the guided range.

Much of this surge is likely attributed to HPC applications, given that we saw Big Tech discuss increased capex spending this year, predominantly for AI infrastructure. Our firm has been especially strong on correlating capex to AI investments for our paid research members, where we held a 1-hour webinar in April discussing our expectations that capex would increase in Q1 in support of AI stocks. We followed this up with free analysis in our newsletter that tracked a 35% YoY increase to $200 billion across Big Tech companies. A disproportionate amount of this will go to Nvidia.

We’re closely tracking Big Tech’s capex plans for 2024 and how this will flow downstream to AI hardware companies. The I/O Fund had a 45% allocation to AI going into 2023, one of the highest on record. Today, the AI allocation is higher with many lesser-known names. Learn more here.here.

There are also reports of Nvidia and AMD fully booking out TSMC’s advanced packaging capacity through the end of 2025, signaling strong demand from some of TSMC’s primary HPC customers. This lends to a strong AI-driven outlook.

Notably, TSMC’s management was much more cautious on the broader semiconductor industry. CEO C.C. Wei explained that for 2024, “We lowered our forecast for the 2024 overall semiconductor market, excluding memory, to increase by approximately 10% year-over-year.”We lowered our forecast for the 2024 overall semiconductor market, excluding memory, to increase by approximately 10% year-over-year.”

That caution does not translate through to AI, with TSMC seeing a “strong AI-related demand outlook.” Wei noted that the “continued surge in AI-related demand supports our already strong conviction that structural demand for energy-efficient computing is accelerating.”

TSMC’s positioning and value to the AI supply chain is expected to increase in the age of AI and high-performance computing. Wei added that TSMC forecasts “revenue contribution from several AI processors to more than double this year and account for low-teens percent of our total revenue in 2024. For the next 5 years, we forecast it to grow at 50% CAGR and increase to higher than 20% of our revenue by 2028.” This will include more than just data center GPUs, but will also include on-device AI.

The I/O Fund has been covering on-device AI on our research site to prepare for the next leg up in AI with many lesser-known names.

Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, as well as various stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.Learn more here.

Analyst Estimates Falling Slightly

What’s interesting to see is that consensus revenue estimates have not only failed to move higher, but have actually been revised lower despite a top and bottom line beat in Q1 and strong guide above consensus for Q2.

Analysts are expecting revenue growth of 29.1% YoY to $19.94 billion in Q2, before accelerating to 32.1% YoY to $22.32 billion in Q3. This is expected to be ‘peak’ growth, with revenue growth rates decelerating back into the low 20% range heading into 2025.

Fiscal Period Chart

Source: I/O Fund

Now compare this to analyst estimates from late January – while Q2’s estimate has moved higher, we’ve actually seen Q3’s revenue estimate revised $110 million lower, even with a $50 million increase to Q4’s estimate. Here’s January’s figures below for reference:

Fiscal Period Chart 2

Source: I/O Fund

It’s not unusual to see EPS estimates come down slightly given the quantified gross margin headwinds TSMC is expecting to see in Q2 with 3nm’s ramp headwind persisting through the rest of the year.

Regarding the Q3 revenue estimates softening by $110 million, it may be linked to management not raising full year guidance, which was addressed in the Q&A from the recent earnings call:

Mehdi Hosseini (SIG):

You had a very nice upside to revenue expectation for the first half of '24, but has kept the year-end unchanged. Is that a reflection of that slow recovery that you were highlighting? Or would you prefer to wait to have more visibility before updating 2024 target?

[…]

Wendell Huang (CFO, TSMC):

Yes. Mehdi, our guidance for the quarterly profile did not change. We always said that quarter-over-quarter, there will be growth. And also, the full year guidance will stay the same. So I don't think there is a so-called upside, as you just said.

—End Quote

Conclusion:

As we’ve emphasized in this analysis and many others on AI stocks, the weakness is coming from non-AI segments. TSMC is a bellwether for semiconductors and can offer unparalleled visibility. In other commentary, this is what management stated in terms of where a lack of upside is coming from, which matches our understanding.

“Yes, smartphone end-market demand is seeing gradual recovery and not a steep recovery, of course. PC has been bottomed out and the recovery is slower. However, AI-related data center demand is very, very strong. And the traditional server demand is slow, lukewarm. IoT and consumer remain sluggish. Automotive inventory continues to weaken.” -TSMC

Our firm closed our TSMC position late last year for a 22% gain, when it was at $92. We decided to instead focus on stocks with heavier AI concentration with less geo-political risk. The stock has risen an impressive 62% since then. Around that time, we re-allocated and built an AI position that is up 51% in a similar time frame. We continue to be focused on stocks with high AI concentration and TSMC will remain on our watchlist as we build out our AI portfolio with many lesser-known names.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

Recommended Reading:

Dell Q1 Earnings: AI Server Shipments up 113% QoQ, Margins Contract

Posted on by io-fund

Dell posted strong AI server order revenue of $2.6 billion with shipments of $1.7 billion, representing growth of 113% QoQ from $800 million last quarter. The backlog of $3.8 billion grew 31% QoQ, which is slower growth than we saw last quarter of 81% QoQ.

Margins contracted and this was a main focus in the Q&A. The company reported a gross margin of 21.63% down 219 basis points. This is the lowest gross margin in two years, dating back to July of 2022. The operating margin is slim at 4.14% down 254 basis points from last quarter. This is the lowest operating margin dating back to January 2021.

Revenue beat this quarter for growth of 6.2%. There was a marginal raise for next quarter revenue that also flowed through to a marginal raise for the fiscal year. GAAP EPS beat whereas adjusted EPS missed by $0.02. The guide for adjusted EPS missed at $1.65 guided versus $1.86 expected for Q2.

The AI server revenue is more than we could ask for. As long as this is the bottom for margins, we are good to go with this position. Most roads point toward Dell being a stronger 2025-2026 story due to the timing of the AI PC upgrade cycle and its core server strength being in enterprise. This is why our last write-up was called “Early AI Shoots.” With that said, we are also seeing evidence the AI story is already unfolding. With a little extra effort on technicals, we think Dell will be well worth the effort in 2024, as well.

Revenue and EPS:

Revenue of $22.3 billion beat estimates of $21.7 billion for growth of 6.22%. The company guided for revenue at the midpoint of $24 billion, representing growth of 5%. This is higher than expectations for Q2 of $23.2 billion. The company also raised fiscal year guidance to a midpoint of $95.5 billion, up from a midpoint of $93 billion. Analysts were expecting $94 billion for FY2025.

Per current estimates, we should be at the bottom for Dell.

GAAP EPS of $1.32 beat estimates of $0.77. Adjusted EPS missed by 1.55% with $1.27 EPS reported versus $1.29 expected. Looking forward, management is guiding for adjusted EPS of $1.65 +/- $0.10. This is a miss as analysts were expecting adjusted EPS of $1.86. This miss also led to the Q&A being predominately about margins.

This is the bottom for Dell on adjusted EPS with H2 expected to see over $2.00 adjusted EPS.

Margins:

The bulk of the negative price action after hours is coming from weaker margins. This is because analysts are not convinced that the AI server revenue will be accretive. Management was quite clear that the ISG segment (where AI revenue is recognized) will end the year between 11% and 14% operating margin. This quarter, the ISG segment operating margin was 8% of revenue.

Per our pre-earnings writeup: “The company is not expected to continue this trend of improving profit margins for a few reasons. First, the high-growth AI market is generating lower margins than the company’s other leading products. In addition, the company expects input costs to increase further in FY25, driven by anticipated inflation for component costs as the year progresses. Management also anticipates the pricing environment to be more competitive in FY25.”

  • Gross margin of 21.6% is down 238 basis points from 23.98% in Q1 of last year and is down 219 basis points QoQ. The gross profit was $4.8 billion. Per the opening remarks: “Given inflationary input costs, the competitive environment and the higher mix of AI optimized servers, we do expect our gross margin rate to decline roughly 150 basis points.”
  • Adjusted gross margin of 22.2% is down 230 basis points QoQ and is down 250 basis points YoY.
  • The operating margin of 4.14% is down from 6.68% last quarter. This also marks a 97 basis points decline YoY. This led to operating profits of $920 million.
  • Adjusted operating margin of 6.6% was down 300 basis points QoQ and down 100 basis points YoY. This led to adjusted operating income of $1.47 billion.
  • Net margin of 4.3% was down 90 basis points QoQ yet was up 151 basis points YoY. This led to net profit of $955 million.

Key Segments:

Infrastructure Solutions grew 22% YoY yet declined (1%) QoQ to $9.2 billion. The segment reported $9.3 billion last quarter. Server and networking revenue was $5.5 billion, up 42%

AI-optimized server order revenue increased to $2.6 billion, with shipments up more than 113% to $1.7 billion. This is up from $800 million last quarter for a 40% QoQ acceleration in Q4. The AI server backlog of $3.8 billion represents growth of 31% QoQ, down from 81% QoQ growth last quarter. AI now represents 7.6% of Dell’s revenue, up from about 5% last quarter.

For FY2025, per the CFO: “We expect ISG to grow in excess of 20%, fueled by AI.”

Client Solutions was flat YoY yet increased 2% QoQ to $12 billion. This is up from $11.7 billion last quarter. Commercial rebounded to 3% growth while consumer was down 15%. For FY2025, the CFO stated she expects “CSG business to grow in the low single digits for the year.”

The flat YoY and 2% QoQ may seem nominal but it’s quite important to see this segment bottom finally as it’s been declining for two years (!). Here is what management stated about what to look forward to in this segment: “We remain optimistic about the coming PC refresh cycle driven by multiple factors. The PC installed base continues to age, Windows 10 will reach end of life later next year, and the industry is making significant advancements in AI-enabled architectures and applications. We will continue to focus on commercial PCs, high end of consumer, and gaming, driving a strong attach motion, a strategy that has served us well across various economic cycles.”

For the full year, the company expects: “the combined ISG and CSG business to grow 11% at the midpoint, and our other business to decline, as previously discussed on the Q4 call.”

Cash and Debt:

Dell has operating cash flow of $1.04 billion for a margin of 4.69% in the most recent quarter. Free cash flow of $457 million represents a margin of 2%. This is slim margins for Dell, which can report a FCF margin >10%.

The company has $7.12 billion on the balance sheet with $25.4 billion in debt.

Dell returned $1.1 billion to shareholders through share repurchases and dividends.

Earnings Call:

Margins:

The Q&A was essentially analysts attempting to come up with creative ways to ask how much AI servers are impacting the margins. To cut to the chase, this is what analysts are concerned about:

Question
Toni Sacconaghi (Analysts)

Yes. If I just look year-over-year at the ISG business, storage was perfectly flat. AI servers went from 0 to $1.7 billion, which sort of suggests that traditional servers were flat. So really, the only thing that changed was you added $1.7 billion in AI servers, and operating profit was flat. So does that suggest that operating margins for AI servers were effectively 0? And if that's not the case, how do you square the circle with what I just outlined?

Answer
Yvonne McGill (CFO):

Toni, I'll take that one. So when I look at the overall ISG performance from an operating income standpoint, storage — I'll start with storage, right? Operating income was low in storage. You know that Q1 is seasonally our lowest revenue quarter from a storage perspective. When the revenue declines, the business de-scales. And so we saw that evidenced in the Q1 results. And while OpEx remains unchanged, to the point you're making, the OpInc rates decline.

In traditional servers, we saw strength in large enterprise and large bid mix. So a shift there a bit, which, as you know, that drives lower margin rates. When I look into Q2 and FY '25 though, I'd tell you that we expect ISG OpInc rates to improve as we talked about in the guide over the year, and really deliver against our long-term framework that 11% to 14%. So I think what we saw in the first quarter was multifaceted, but we do continue to expect recovery as the year goes on. And those AI-optimized servers, we've talked about being margin rate dilutive, but margin dollar accretive. And so you'll continue to see that evidenced in the results also.

–End Quote

Since this is a such an important topic, I’m going to copy and paste another part of the Q&A on this topic that goes over the same question. I’m cutting down the response to the most succinct answer from the CFO.

Question
Erik Woodring (Analysts)

I'm going to kind of hit on a similar topic that everyone has. But Yvonne, you're talking about improving ISG operating margins through the year. Obviously, it seems like the strength and momentum you have in AI servers means that will continue to become an increasing mix of revenue. You also have commodity cost headwinds to contend with.

And so again, I know we've kind of talked about this topic, but maybe on a bit more detailed level, can you just help us understand what are the most significant factors that we should be thinking about that would support ISG operating margin expansion as we work through the year? Is that pricing? Is that mix? Is that storage mix? Just help us understand what are the most important factors there, again, as we look through the year.

[…]

Answer
Yvonne McGill (Executives)

Yes. And the one thing, I don't think I called out specifically, the storage margins will continue to improve also because we will scale, right? We talked about the OpEx, we talked about that level of spend that we have. But as we scale that business, we will get that. And I'll reiterate that we do expect ISG Op Inc [operating income] to finish FY '25 within our long-term framework, so 11% to 14%.

–End Quote

The read-through is there could be a 0% operating margin on servers but storage will make up for it. Per previous comments: “for every $1 of AI server, there's $2 of services, storage and other higher-margin things that come.”

Conclusion:

Dell’s management is confident they will exit the year at a higher margin. Typically, we do close positions with contracting margins. We are making an exception to this rule because Dell is at a bottom both on revenue and earnings. That is key to understanding why we stick with a company or not, which is that a bottom is meant to mark an inflection point.

There are a few irons in the fire: AI servers for cloud service providers and enterprises which includes networking and storage, and then separately, the new upgrade cycle coming for PCs.

Per the trading plan, key levels have to hold for Dell. However, Knox was expecting this pullback and he has a buy plan in mind depending on how the price action plays out. You can reference the webinar from earlier today or the upcoming Positions Report due out early next week to learn more. Technicals are important especially for this position because Dell has rivaled Nvidia on YTD returns. Thus, we want to stay diligent in the event this is a breather before the next leg higher.

Recommended Reading:

Dell Q1 Pre-Earnings: It’s All About the QoQ AI Revenue Growth

Posted on by io-fund

Dell will report its Q1 earnings tomorrow at market close. The market will want to see strong QoQ AI revenue growth. Last quarter, the growth was 40% sequentially in Q4 to $800 million in AI optimized server revenue with a $2.9B backlog. The backlog grew 81% QoQ from $1.6B. Super Micro is hitting capacity, and building quickly to increase that capacity. In the meantime, it appears Dell is stepping in to fill AI server demand as a runner-up to SMCI.

For example, recently an analyst stated that Tesla is filling the bulk of its AI server order with Dell. Per the article, Amit Daryanani of Evercore stated: “While our impression is that SMCI has won some of the Tesla AI server business as well, allocations are heavily skewing towards Dell.”

It is not terribly difficult to imagine Dell as #2 for AI servers as it’s been #1 globally across all servers for some time. It’s estimated that SMCI will have about $25 billion in production capacity, which we discussed here. Current estimates are for an AI server market of $40 billion by end of 2024. Whether it’s the near-term TAM or if we simply look at Nvidia’s beat/raises, the conclusion is that more than just Super Micro will be needed to build AI servers.

Revenue

The management guide for the next quarter is $21 billion to $22 billion, representing YoY growth of 2.8% at the midpoint. Analysts are forecasting 3.3% growth for $21.61 billion. The company is expected to return to growth after six quarters of negative growth with a full recovery by H2.

Operating Segments

Revenue is rebounding as the Infrastructure Solutions Group (ISG) is expected to grow in the mid-to-high teens in Q1, led by traditional and AI server growth. ISG revenue declined for the fourth consecutive quarter in Q4. The revenue decreased by (-6%) YoY but grew by 10% sequentially to $9.3 billion. The main highlight of the last earnings report was that AI-optimized orders grew sequentially by 40%. The company reported AI revenue of $800 million, up from $500 million in Q3. Despite now being around only 4% of the total Q4 revenue, analysts expect strong AI revenue growth. Morgan Stanley analyst Erik Woodring expects AI revenue to reach $10 billion in the current FY 2025. This would represent fairly dramatic growth between now and calendar January 2025, yet lines up with the 2024 TAM of $40 billion and the delta of what SMCI is producing.

Management highlighted in the earnings call that the recovery in the PC market has been pushed to the second half of the year. However, there are favorable spots as the Q1 guide calls for a decline of (-3%) YoY in the Client Solutions Group (CSG), which is better than the decline of (-12%) YoY to $11.7 billion and a decline of (-23%) YoY in the same period last year.

Jeff Clarke, COO of the company, said in the earnings call, “In CSG, we remain optimistic about the coming PC refresh cycle as the PC install base continues to age, Windows 10 reaches end of life later next year, and the industry makes advances in AI-enabled architectures and software applications.”

We discussed the AI PC opportunity more in our previous write-up on Dell with a statement from management that the AI PC market will “absolutely” be bigger in H2 2024  than it was in H1 2024.

Margins

In the last quarter, margins improved YoY as the company juggles margin contraction and margin expansion in varied segments. The company is not expected to continue this trend of improving profit margins for a few reasons. First, the high-growth AI market is generating lower margins than the company’s other leading products. In addition, the company expects input costs to increase further in FY25, driven by anticipated inflation for component costs as the year progresses. Management also anticipates the pricing environment to be more competitive in FY25.

  • Q4 gross margin increased 70 bps sequentially and 80 bps YoY to 23.8%.
  • Adjusted gross margin improved 80 bps sequentially and 70 bps YoY to 24.5%, partly helped by the higher revenue mix of ISG revenue.
  • The company also witnessed pricing pressures in PCs and servers, however, remained focused on profitable opportunities and expects this discipline to go forward.

Adjusted gross margin guide for the next quarter is 22.5%, down 200 bps sequentially and 220 bps YoY. The decline in gross margin is due to the seasonally lower storage revenue mix, higher AI-optimized server revenue mix, pricing pressures, and higher inflationary cost components.

  • Operating margin remained flat sequentially and improved 190 bps YoY to 6.7%.
  • Adjusted operating margin improved 80 bps sequentially and 90 bps YoY to 9.6%.

The improvement in the margins was due to higher gross margins and cost-cutting initiatives. The company also announced a reduction of staff in the recent quarter. Management expects the adjusted operating margin to trend lower sequentially in Q1 due to the factors discussed in the previous paragraph. Management expects improved performance as the year progresses.

  • Net margin of 5.2% was up 270 bps from the year-ago quarter.
  • The adjusted net margin improved 190 bps YoY to 7.2%.
  • Adjusted EPS came at $2.20 and beat estimates by 27.9%.
  • Management expects Q1 adjusted EPS to be $1.15 at the midpoint and is lower due to the factors already discussed above. The analysts expect Q1 adjusted EPS of $1.25, representing a YoY decline of (-4.7%).

Cash Flow and Balance Sheet

Last quarter, Dell announced a 20% hike in the annual dividend to $1.78 per share and substantial share buyback program reflects Dell's confidence in sustained cash flow generation and long-term value creation. 

  • Operating cash flow of $1.53 billion in Q4 represented a margin of 6.9% compared to $2.71 billion or 10.8% of revenue in the same period last year.
  • Adjusted free cash flow for Q4 was $1.01 billion or 4.5% of revenue compared to $2.27 billion or 9.1% in the same period last year. However, for FY2024, the operating cash flows grew 143% YoY to $8.7 billion. Management has been focused on improving cash and working capital.

The company had $8.7 billion in cash and investments and $26 billion in debt. Debt is down from $26.6 billion in the September quarter as the company is focused on deleveraging. The company also reached its core leverage target of 1.5x, down from 1.6x in Q3 and 1.8x in the same quarter last year.

What to Watch

AI-Optimized Server and Backlog:

AI-optimized server backlog increased from $1.6 billion in Q3 to $2.9 billion in Q4. This is a five-quarter backlog. Jeff Clarke also mentioned the strong demand in the earnings call and how they are helping their customers who are in the early stages of AI.

“AI-optimized server orders increased by nearly 40% sequentially. We shipped $800 million of AI-optimized servers, and our backlog nearly doubled sequentially, exiting the fiscal year at $2.9 billion. Demand continues to outpace GPU supply, though we are seeing H100 lead times improving. We are also seeing strong interest in orders for AI-optimized servers equipped with the next generation of AI GPUs, including the H200 and the MI300X….”

Management also said that they will ship more in Q1 than in Q4 and any guide on the AI revenue is to be watched.

There are reports that lead times for servers powered by Nvidia’s H100 GPUs have come down eight to 12 weeks from the earlier 39 weeks, which should help to increase the AI revenues in coming quarters.

Dell’s Nvidia partnership and enterprise opportunity

At the Nvidia GTC event, Jensen Huang spoke iabout Dell AI servers for enterprises. "Everybody who is building these chatbots and Generative AI, when you are ready to run it, you need an AI factory and nobody is better at building end-end systems of very large scale for the enterprise than Dell. Any company and every company needs to build AI factory and it turns out Michael (Dell) is here he would happy to take orders.” you need an AI factory and nobody is better at building end-end systems of very large scale for the enterprise than Dell. Any company and every company needs to build AI factory and it turns out Michael (Dell) is here he would happy to take orders.” The company also recently announced Dell servers that support the latest Blackwell chips. The new servers offer liquid cooling technology that is expected to consume lower power.

We covered the enterprise opportunity more thoroughly in our last write-up.

Storage recovery

Storage revenue declined by (-10%) YoY and up sequentially by 16% to $4.5 billion. Management mentioned that Q1 is seasonally low for storage revenue, and that storage recovery typically lags servers by a couple of quarters. They mentioned that their storage business is expected to have strong growth opportunities in unstructured data. They are also optimistic about tapping the opportunity on-premises or at the edge network.

Per the last earnings call: “I need to mention we got a storage opportunity in there, that we have a networking opportunity in there, and we have a services opportunity in there and to go for the last of the bunch of financing opportunities. So those — how could you not be excited about that given the demand environment?”

AI PCs

During the last earnings call, management said that PC recovery was pushed to the second half of the year. However, they were positive on the coming PC refresh cycle and longer-term impact from AI.  The company also recently announced new AI-PCs during the Dell Technologies World. According to Morgan Stanley, 64% of the new PCs in 2028 are expected to be AI PCs, of which Dell will be a large beneficiary.

Conclusion

Dell has done quite well recently. The stock is up 69.2% since the company reported Q4 results and has outperformed Nvidia, Super Micro, and the Nasdaq-100 index during this period. In our last write-up, we focused on Dell’s valuation as a primary part of the thesis. This was similar to our Super Micro thesis, which centers around the pivotal moment that a commoditized hardware company becomes valued like an AI stock. Dell is trading about one-third what SMCI is trading at on sales, and is trading at about two-thirds what Super Micro is trading at on PE ratio. Dell has about 5% AI revenue compared to Super Micro’s 50%. The company may end the year with 10% of revenue from AI. With that said, Dell is a cash cow with a dividend while Super Micro has to raise cash. So, this is not exactly apples-to-apples, but for those who are patient, we think Dell will close its valuation gap with SMCI.

Let’s see what happens tomorrow night. You’ll get a post-earnings writeup from the fundamentals team after market close. Knox will also address his trading plan for Dell in the weekly Advanced Market Signals webinar held Thursday at 4:30 p.m. Eastern.

Recommended Reading:

Nvidia Q1 Earnings Preview: Blackwell And The $200B Data Center

Posted on by io-fund

This article was originally published on Forbes onForbesForbes on May 22, 2024,05:58am EDT

Nvidia’s management team will focus on the H200 in the upcoming earnings call, but make no mistake, we will end this year in full-on Blackwell territory. The new architecture is at the forefront of training and inference for trillion+ parameter models. More than five years ago, I called CUDA the moat for Nvidia’s AI data center story, yet should that moat become breached, the company’s rapid product road maprapid product road map is the first line of defense.

Nvidia is the world’s leading GPU design company, which bears reminding since such little emphasis in Wall Street is placed on what the designs intend to solve. For those paying close attention, there are clues that the company’s fast and furious data center growth will see a second wind with Blackwell.

Nvidia is Hitting Peak Growth: The Hopper Impact

Last quarter in fiscal Q4, Nvidia reported growth of 265%. Last quarter is likely to be peak growth for the company. We pointed this out three months ago when our analysis stated: “Even if we see a beat and raise, the slowing growth in the second half will be hard to overcome due to high comps. As mentioned in the introduction, Nvidia will begin to lap some stellar quarters come the October CY2024 quarter as the growth in October of CY2023 was 205.5% YoY.”

At time of writing, the revenue estimates for Nvidia point to growth of 242%. A beat/raise this quarter is not likely to flow through to a higher growth rate in H2 compared to what we saw in Q4 and what we will see in Q1. Therefore, even if Q1 inches slightly past fiscal Q4 tomorrow evening, we have hit peak growth.

Typically, a growth investor should be cautious when a company hits its peak growth rate after a drastic rise in the stock price. Here is a chart we published three months ago updated with current estimates:

Revenue Growth YoY

Source: I/O Fund

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Organic Growth

However, Nvidia’s margins and earnings expansion are creating an outlier of a stock. There are rumors Blackwell GPUs will be priced starting at $30,000 to $40,000 but will have more expensive memory components with HBM3e. As long as margins remain within range, this will not be consequential considering Nvidia is posting organic growth.

This is drastically different than a stock that relies on growth at any cost, growth at any cost, which is where rapid growth is bought rather than earned. The quality of Nvidia’s growth is much better than what tech investors are used to, and this is predominately why Nvidia stock is resilient (within reason; there will always be selloffs in the market). As supply/demand becomes more balanced, it will be Nvidia’s aggressive product road map, which in many cases is designed to compete with themselves, that will keep pricing power stable, starting with Blackwell.

For example, there are recent reports that AWS is pausing orders on Hopper GPUs in anticipation of Blackwell GPUs. The market may interpret this as weakness, but this is actually a sign of immense strength. Nvidia needs to pass the baton from the H100s and H200s to the Blackwell architecture for the stock price to extend. We are less concerned with what happens in the immediate-term, and in fact, the I/O Fund has stated a few times that Nvidia is a buy on dips, implying the stock won’t go up forever. Instead, we are encouraged to see early signs of a careful transition to the next architecture to help inform our next buy.

Nvidia’s $150B to $200B Data Center: The Blackwell Effect

There is nothing quite like rapid earnings revisions intra-quarter to determine the quality of a position. For example, consider that Nvidia sold off directly after the November report, yet has gone up a rapid 91% since. The earnings revisions are why Nvidia is so strong intra-quarter:

  • This upcoming quarter is expected to report growth of 242%. Last August, the growth for the April quarter was expected to be 91.6%. Only three months ago, the estimates for the April quarter were for growth of 197.5%. Stated in terms of revenue, this quarter’s revisions have doubled from $13.8 billion in August to $24.5 billion.
  • Next quarter, the company is expected to report growth of 98.7%. This was expected to be growth of 44.6% last November. Stated in terms of revenue, next quarter’s revenue has gone up $7 billion from $19.5 billion in November to $26.7 billion in May. In the past three months alone, the estimates went up $4 billion.

Below, we discuss why margins, cash flow and strong earnings support our decision to buy on dips. However, equally as important, there is also a decent probability that FY2026 and FY2027 revenue estimates are too low. The most bullish analyst from KeyBanc is calling for a $200 billion data center segment by 2025. HSBC believes Nvidia’s FY26 revenue could be as high as $196 billion, which implies about a $192 billion data center segment. Loop Capital foresees a $150 billion data center segment as soon as this year, while Wells Fargo has estimates for a $150 billion data center segment by 2027. The exact timing from these analysts has a range, but the conclusion is very similar.

Let’s breakdown the weight of those comments with some back-of-the-napkin math, which shows that analysts are currently estimating about $122.4B in data center revenue for FY2026 (calendar year 2025). This is about 65% lower than the more bullish analyst estimates of $200 billion in data center revenue.

  • Q1 FY25: $20.75B
  • Q2 FY25: $23B
  • Q3 FY25: $25.5B
  • Q4 FY25: $27.7B
  • Q1 FY26: $27.87B
  • Q2 FY26: $29.7B
  • Q3 FY26: $31.51B
  • Q4 FY26: $33.25B
Data Center Revenue

Source: I/O Fund

These are the current estimates, yet if the analysts are correct, then the far right of the graph will end in $50B quarterly revenue. The difference between the current consensus and this much higher trajectory can be summarized in one word: Blackwell.

There are additional data points in the supply chain and on the demand side that support Blackwell seeing an increase in orders over Hopper. For example, Taiwan Semi’s CoWos capacity, which is essential for Blackwell’s architecture, is estimated to rise to 40,000 units/month by the end of 2024, which is more than a 150% YoY increase from ~15,000 units/month at the end of 2023. Applied Materials has boosted its forecast for HBM packaging revenue from a prior view for 4X growth to 6X growth this year. According to Wells Fargo, Taiwanese export data rose 360% year-over-year and 33% quarter-over-quarter, and is often correlated to Nvidia data center revenue.

Note: It’s important to remember this is not earnings call on what will happen tomorrow evening as the revenue will be reported when it ships to the customer. However, it helps to consider there are directionally bullish data points should the market sell off following the report and provide us a lower entry.

Notably, the premiere component for the H200 and Blackwell is HBM3e memory, which is currently supply constrained. Samsung and SK Hynix are both re-allocating ~20% of DRAM production capacity to HBM to meet high demand, while HBM4 roadmaps are being accelerated.

CEOs of major companies in AI acceleration are in agreement the total addressable market is much, much larger than today’s market size. Lisa Su of AMD has stated the AI chip market will reach $400B by 2027. Intel’s CEO has stated AI chips will become a $1T opportunity by 2030, which is almost twice the size of the entire chip industry in 2023.

Big Tech capex is supporting this growth. Our firm has been especially strong on correlating capex to AI investments for our paid research members, where we held a 1-hour webinar in April discussing our expectations that capex increases in support of AI stocks. We followed this up with free analysis in our newsletter that tracked a 35% YoY increase to $200 billion across Big Tech companies. A disproportionate amount of this will go to Nvidia.

We’re closely tracking Big Tech’s capex plans for 2024 and how this will flow downstream to AI hardware companies. The I/O Fund had a 45% allocation to AI going into 2023, one of the highest on record. Today, the AI allocation is higher with many lesser-known names. Learn more here.here.

China:

A curveball in the report could be higher than expected China revenue due to China-specific GPUs, such as the H20. Similar to Big Tech in the United States, China’s main players are stockpiling GPUs to secure their lead in AI.

Regarding China, last quarter, the following was stated: “Growth was strong across all regions except for China, where our Data Center revenue declined significantly following the U.S. government export control regulations imposed in October. Although we have not received licenses from the U.S. government to ship restricted products to China, we have started shipping alternatives that don't require a license for the China market. China represented a mid-single-digit percentage of our Data Center revenue in Q4, and we expect it to stay in a similar range in the first quarter.”. Although we have not received licenses from the U.S. government to ship restricted products to China, we have started shipping alternatives that don't require a license for the China market. China represented a mid-single-digit percentage of our Data Center revenue in Q4, and we expect it to stay in a similar range in the first quarter.”

Nvidia’s Blackwell will Answer to Hopper’s Excellence

The product road map is the single most important thing investors should be focused on. A good chunk of the AI accelerator story is understood at this point. What is not understood is how aggressive Nvidia is becoming by speeding up to a one-year release cycle for its next generation of GPUs instead of a two-year release cycle.

This means Nvidia is competing with itself by putting Blackwell dangerously close to Hopper’s product cycle. This move is bold, it’s daring, and it’s absolutely necessary.

Here is the very ambitious eight month schedule Nvidia has set for itself:

  • The H200 with HBM3e is shipping now.
  • The B100 and GB200 are shipping in late 2024.
  • The B200 will be released in early 2025.

The Blackwell architecture remains on 4nm dies, similar to the Hopper architecture. What is different is that Blackwell has 2 reticle-sized GPU dies. Reticle size refers to the limit in the chip surface that can be exposed by a single mask. The limit is set by the lithography equipment. At one point it was expected Blackwell would be on 3nm dies, yet due to reasons unknown, Nvidia is moving forward with 4nm. Since Nvidia is not able to offer a more advanced process node, the company is instead doubling the silicon. The Blackwell architecture is rumored to be priced between $30,000 to $40,000, which is higher than the H100’s reported $25,000 cost. This is competitive considering B200 will offer nearly 30X better performance (benchmarks are provided by Nvidia).

Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, as well as various stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.Learn more here.

B100 & B200

The B100 is a replacement chip, which means customers can remove the H100 and place the B100 in the same rack. The B100 is air-cooled and doubles NVLink speeds from the H100 and H200. The B100 is will ship in Q3 and provide upgrades to memory from 80GB in the H100, 141GB in the H200 to 192GB in the B100.

The B200 GPU chipset due in Q1 of next year will deliver a 2.5X training improvement and 5X inference improvement over the H100. This is due to the B200 having 208 billion transistors compared to the H100’s 80 billion transistors.

The B200 will also have 20 petaflops of FP4 compared to the H100’s 4 petaflops of FP8 reaching 32 petaflops of FP8 in the DGX H100 systems. The difference is that the smaller bit size allows for an economical way to achieve more speed when giving up a small amount of accuracy doesn’t make a critical difference. This also helps in the face of a slowing Moore’s Law. Following the release of the Hopper H100, Intel released Gaudi2 which supports FP8. About two years back, chip makers Graphcore, AMD and Qualcomm pushed for an industry-standard for floating point format FP8. However, the recent B200 will have a second-generation transformer engine that supports 4-bit floating point (FP4) with the goal of doubling the performance and size of models the memory can support while maintaining accuracy.

Part of the secret sauce of the H100 is the transformer engine. The A100 lacked support for FP8 compute at default whereas the H100 leveraged a transformer engine to switch between FP8 and FP16, depending on the workload. The second-generation transformer engine in the Blackwell architecture will offer FP4. This is helpful because AI models are moving toward neural nets that lean on the lowest precision and yet still yields an accurate result. In this case, 4 bits double the throughput of 8-bit units, compute faster and more efficiently, and they require less memory and memory bandwidth.

The main feature from the Transformer Engine is the ability to choose what precision is needed for each layer in the neural network at each step, transitioning between 4-bits, 8-bits, 16-bits, or 32-bits. The H100 is able to do matrix math with two forms of 8-bit numbers with either 5-bits as the exponent or 4-bits as the exponent: E5M2 and E4M3. This is important because the E4M3 may be favored for back propagation while E5M2 may be favored for inferencing.

Building on the first-gen transformer engine, the B200’s second-gen transformer engine will support double the compute and model sizes with new 4-bit floating point AI inference capabilities.

GB200 NVL72 Systems:

According to the current product road map, the GB200 will be released before the B200 GPUs. The real fireworks will begin with the GB200 NVL36/NVL72 systems in late 2024 and then continue with the B200 GPUs in early 2025.

The GB200 Grace Blackwell chip connects two Blackwell Tensor core GPUs with the Nvidia Grace CPU. The GB200 NVL 72 rack-scale exascale supercomputer, connects 36 Grace CPUs with 72 Blackwell GPUs in a rack-scale design with liquid cooling. We’ve written in-depth about liquid cooling for our premium research members, learn more here.about liquid cooling for our premium research members, learn more here.

According to HSBC, the average sales price of NVL36/NVL72 server rack will be $1.8 million and $3 million, respectively. Notably, its expected the GB200 systems will have strong margins due to using an in-house CPU.

Here are the stats provided from Nvidia on how it will compare:

  • 30X faster real-time trillion-parameter LLM inference
  • 4X LLM training
  • 25X energy efficiency
  • 18X data processing
GB200 System

Source: Nvidia, the GB200 System due to ship in Q4 this year

The GB200 will provide 4X faster training performance than the H100 HGX systems and will include a second-generation transformer engine with FP4/FP6 Tensor core. As stated above, the 4nm process integrates two GPU dies connected with 10 TB/s NVLink with 208 billion transistors.

NVLink Switch is a major component to the Blackwell upgrade. Fifth-generation NVLink enables multi-GPU communication at high speed, reaching 1.8 TB/s bidirectional throughput or 14X the bandwidth of PCIe for a single GPU.

For the NVL72 systems, NVLink Switch can reach 130 TB/second, which is “more than the aggregate bandwidth of the internet.” Therefore, it’s the compute and the communication capabilities of the upcoming GB200 release that are important to consider. The 72 GPUs in the NVL72 can be used as a single accelerator for 1.4 exaflops of AI compute power.

Why GB200s and B200s will Drive more Demand:

To scale up a model, AI departments utilize a Mixture of Experts (MoE) approach. MoE distributes a computational load across “multiple experts” (or neural networks) and trains across thousands of GPUs using what is called model and pipeline parallelism. This enables more compute-efficient pretraining yet the parameters still need to be loaded in RAM, so the memory requirements remain high.

For inference, GB200 will deliver “a 30X speedup” for 1 trillion­­+ parameter models by leveraging FP4 precision and fifth-generation NVLink. This is what that the leap in real-time throughput for inference looks like for a 1.8 trillion parameter model:

GPT-MoE Chart

Source: Nvidia Blog

Blackwell is for the trillion+ parameter era of generative AI. The architecture is designed to support the largest language models today and is future-proofed with the GB200 NVL72 rack-scale solution, which is an exascale computer that contains up to 5,000 NVLink cables that total 2 miles. You also have to consider that AMD was coming to market in the first release with nearly 2X memory as the H100. Nvidia is remaining competitive with HBM3e and soon HBM4 to help models run in memory.

The GB200 also has a new decompression engine that allows GPUs to process and decompress compressed data sets to speed up database queries. Coupled with 8 TB/s of high memory bandwidth and high speed NVLink, the GB200 systems deliver up to 18X faster database queries. In addition to this, there is up to 13X faster physics-based simulations compared to CPUs and 22X faster simulations for computational fluid dynamics (CFD).

More on Memory:

High bandwidth memory (HBM) offers higher bandwidth, capacity, performance, and lower power by vertically stacking up to twelve DRAM memory chips to shorten how far data has to travel, while also allowing for smaller form factors. Stacked memory chips are connected through something called “through silicon vias” or TSVs. HBM is increasingly being used to power machine learning, high performance data centers, and more recently, generative AI models.

CoWoS (chip-on-wafer-on-substrate) architecture refers to 3D stacking of memory and processor modules layer by layer to create chiplets. The architecture leverages through-silicon vias (TSVs) and micro-bumps for shorter interconnect length and reduced power consumption compared to 2D packaging.

The advanced CoWoS packaging that is needed to combine logic system-on-chip (SoC) with high bandwidth will take longer, and thus, it’s expected that Blackwell will be able to fully ship by Q4 this year or Q1 next year. How management guides for this will be up to them, but commentary should be fairly informative by Q3 time frame.

GPUs will move from 8Hi configurations to 12Hi HBM3e configurations by 2025. These upgrades are needed to train and deploy large models with trillions of parameters in the near future. What Nvidia’s product road map intends to accomplish is a way forward for real-time inference that is computationally efficient, cost-effective and energy efficient.

My firm has covered HBM3e in the past when we stated in a premium research report six months ago:

The recent surge in generative AI and AI GPUs, spurred by the success of OpenAI’s ChatGPT and development of hundreds of other large language models, are forecast to bring about a new DRAM market, underpinned by high-bandwidth memory (HBM) and DDR5

[…] HBM3 and HBM3e are becoming the next battleground for memory chip manufacturers as well as AI chip design companies, especially Nvidia and AMD, who are pushing the boundaries with the amount of memory bandwidth in each GPU.

AMD’s competing GPUs, the MI300 series, substantially boosted memory and bandwidth relative to the H100, utilizing Samsung’s HBM3. The MI300A is shipping with 128GB HBM3 memory while the MI300x ships with 192GB memory and 5.2 TB/s of bandwidth – that’s 1.6x more bandwidth and 2.4x more HBM3 density than Nvidia’s H100.

Nvidia is rapidly moving forward with its GPU roadmap, as it aims to launch its next-gen H200 and B100 GPUs next year followed by the X100 GPU in 2025 – each GPU will accelerate AI inference times along an exponential curve, thus creating a need for more memory and more bandwidth.”

Nvidia’s Fiscal Q1 Report Card: What You Need to Know

Now that we’ve touched base on the importance of Blackwell, let’s get prepped for this evening. Here is what analysts are expecting:

Revenue:

  • For Q1, Nvidia is expected to report revenue of $24.6 billion, for growth of 242%. Management guided for revenue of $24 billion +/- 2%, for a growth rate of 233.7%, at the midpoint.
  • Next quarter, the company is expected to report revenue of $26.8 billion for growth of 98.7%.
  • On a fiscal year basis, the company is expected to report revenue of $113.2 billion for growth of 85.8%. These estimates have doubled since August.
  • The FY2026 growth rate of 26.1% for revenue of $142.8 billion, and then FY2027 growth rate of 17.7% for revenue of $168 billion, is where estimates are too low if there is a $200 billion data center segment in the medium-term.

EPS:

In Nvidia’s case, top line growth is flowing through to bottom line growth disproportionately.

  • For Q1, Nvidia is expected to report adjusted EPS of $5.58 for growth of 411.9%.
  • Next quarter, Nvidia is expected to report adjusted EPS of $6.00 for growth of 122.1%.
  • For FY2025, adjusted EPS is expected to be $25.4 for growth of 96%. FY2026 adjusted EPS is expected to be $32.2 for growth of 26.6%.

Margins:

As the story for Nvidia unfolds over the next few years, keep an eye on margins as software will begin to positively impact the company with higher margins. The company is expected to end the year with $2 billion in software revenue.

In the near-term, and especially for this earnings report, it’s likely that analysts ask about the costs associated with HBM3e as memory components are increasing in costs. TrendForce has reported that HBM3 prices have risen 5-fold since 2023. HBM3e prices will be even higher than HBM3. Analysts may also ask about the yield issues that major memory suppliers SK Hynix, Micron, and Samsung are reported to be facing, given the complexities in the manufacturing process for HBM3e and its longer production cycle. For our premium members, we’ve discussed what stocks will benefit from this leading trend in 2024.our premium members, we’ve discussed what stocks will benefit from this leading trend in 2024.

  • Management guided for gross margin of 76.3% for gross profit of $18.3 billion. If reported in line, this will represent flat growth QoQ and 1170 bps expansion from 64.6% in the year ago quarter.
  • Management guide for adjusted gross margin is 77%. If reported, it will represent 30 bps QoQ expansion and 1020 bps expansion YoY.
  • Operating margin was guided to be 61.7% for operating profit of $14.8 billion. If reported, this will be flat QoQ yet up a whopping 32-points from 29.76%. This is the most rapid operating margin expansion that I have personally witnessed. It is rare, even with a hyper growth company to report a 32-point expansion on this line item.
  • Adjusted operating margin of 66.6% will be flat QoQ and up from 42.4% in the year ago quarter.
  • Net margin guide is 52.1%. If reported, it will be down (3.5%) sequentially. However, a remarkable 23.7% expansion on a YoY basis.

Cash and Debt:

Last quarter, Nvidia reported operating cash flow of $11.5 billion for a margin of 52%. The free cash flow of $11.2 billion represents a margin of 50.7%. The fiscal year free cash flow of $26.9 billion was more than 7 times higher than the fiscal year 2023 free cash flow of $3.75 billion.

Key Segments:

The data center segment reported revenue of $18.4 billion for growth of 409% YoY and was up 29% QoQ. Nvidia’s tough comps kick in with the Q2 July quarter when the company reported DC revenue of $10.3 billion for growth of 171%, and thus the guide is key. Management will not guide to DC specifically but it’ll be easy enough for analysts to read through the lines that any beat/raise on Q2 is likely coming from the DC segment.

The CFO mentioned in the earnings call that 40% of the revenue came from inference in the past year. “Fourth quarter data center growth was driven by both training and inference of generative AI and large language models across a broad set of industries, use cases and regions. The versatility and leading performance of our data center platform enables a high return on investment for many use cases, including AI training and inference, data processing and a broad range of CUDA accelerated workloads. We estimate in the past year approximately 40% of data center revenue was for AI inference.”

Gaming revenue of $2.8 billion was up 56% YoY and was flat QoQ. Nvidia has fared better than gaming peers due to the timing of the RTX 4000 Series, which I covered in a previous editorial: “Nvidia Stock: Evidence Gaming has Bottomed and Why It’s Important.”Nvidia Stock: Evidence Gaming has Bottomed and Why It’s Important.” With that said, management guided for a seasonal decline in gaming.

  • Professional Visualization reported revenue of $463 million for growth of 105% YoY and 11% QoQ.
  • Automotive reported revenue of $281 million, down 4% YoY but up 8% QoQ.
  • OEM & Other reported revenue of $90 million, up 7% YoY and 23% QoQ.

Conclusion:

As stated on Making Money with Charles Payne today, the upcoming earnings report is only one piece to the story, whereas the ultimate fireworks will be when the Blackwell architecture begins to ship Q3-Q4. The product road map is communicating that AI accelerators are secular; not cyclical.

We will see peak growth this quarter – even if we get that beat that Nvidia is becoming known for, H2 will certainly see a slowdown. This is normally a great jumping off point for investors but those who stick with Nvidia will be rewarded for a few reasons:

  • This is an organic growth company, which is very rare in tech where most growth is bought. That means Nvidia is likely to remain strong on margins and EPS, even in the face of slowing revenue growth.
  • The supply chain is providing hints that analyst estimates for the data center are too low – there could be up to 65% upside on those estimates in the next 6-7 quarters.
  • The reason I side with Keybanc, Loop and others in thinking the estimates are too low – and this last point is critical – is because Nvidia is speeding up its product road map and introducing the Blackwell architecture to address the trillion+ parameter models that Big Tech will compete to create and train.

Nvidia has sold off 10% or greater about 9 times since the 2022 low. We see any dips as buying opportunities as we brace for Blackwell toward the end of this year.

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 shares in NVDA at the time of writing and may own stocks pictured in the charts.

Recommended Reading:

Nvidia Q1 Earnings: “We will see a lot of Blackwell revenue this year.”

Posted on by io-fund

Nvidia impressed again with a beat this quarter and a raise next quarter. However, that wasn’t enough to move the stock price. It was during the earnings call that we saw the stronger price action when management discussed the Blackwell architecture. The first question on the call was a direct question on when Blackwell will be in production:

Q: “So this year, we will see Blackwell revenue, it sounds like?”

A: The CEO offered one, simple sentence in a measured tone: “We will see a lot of Blackwell revenue this year.”

The call could have probably ended there as that one simple sentence shed light on what has been the predominant concern — can Blackwell keep up with Hopper. If you read my analysis published in Forbes this morning, then you know that the I/O Fund thinks a $200 billion data center segment is in sight by the end of CY2025.

There were other bullish comments about Blackwell ramping this year, such as “We will be shipping [Blackwell]. Well, we've been in production for a little bit of time. But our production shipments will start in Q2 and ramp in Q3, and customers should have data centers stood up in Q4.” This was strong language to use as it’s quite clear that Hopper has runway left given the beat/raises we saw in this quarter. To have the two architectures merge seamlessly in terms of timing in H2 is quite ideal.

Revenue and EPS:

Revenue of $26 billion is up 18% QoQ and up 262% from the year ago quarter. This means Q4 was officially the peak quarter for revenue growth, which we covered previously. Revenue beat expectations by 5.9% with analysts expecting $24.6 billion in revenue for growth of 242% YoY.

Nvidia will now face tougher comps as it laps Hopper’s impact from last year. The company is off to a decent start by forecasting next quarter revenue of $28 billion. Analysts were expecting $26.84 billion. This represents growth of 107% up from growth of 98.8% expected.

The intra-quarter revisions are particularly strong. However, regardless of ongoing upward revisions, it’s unlikely we return to the peak growth we saw in Q4 and Q1 (current quarter).

  • GAAP EPS of $5.98 compares EPS of $4.93 last quarter. This represents QoQ earnings growth of 21.3% and YoY earnings growth of 629%.
  • Adjusted EPS of $6.12 beat estimates of $5.58. This represents growth of 18.6% QoQ and 461% growth YoY.

Margins:

As expected, margins have expanded across the board.

  • GAAP gross margin of 78.4% compares to 64.6% in the year ago quarter, up 13.8 points YoY and up 240 bps from last quarter. This represents gross profit of $20.94 billion.
  • We will see a softening in gross margin due to a deceleration from peak revenue. Management is guiding for GAAP gross margin of 74.8% for next quarter with added color that the full year gross margins “are expected to be in the mid-70% range.”
  • Adjusted gross margin of 78.9% compares to 66.8% in the year ago quarter, up 12.1 points YoY and 220 bps from last quarter. Management is guiding for adjusted gross margin of 75.5%. This represents adjusted gross profit of $21.1 billion.
  • GAAP operating margin of 64.9% compares to 50.3% in the year ago quarter. This represents operating profit of $16.9 billion.
  • For next quarter, GAAP OPM is expected to soften to 60.5%, according to management’s guidance.
  • Adjusted operating margin of 69.3% was reported for Q1, representing adjusted operating profit of $18.05 billion.
  • For next quarter, adjusted operating margin is expected to soften to 65.5%.
  • Net margin this quarter was 57.1% compared to 28.4% in the year ago quarter, and was up 150 basis points QoQ. This represents net profit of $14.9 billion. The adjusted net margin this quarter was 58.5%.

Cash Flow:

Cash flow was strong (unsurprisingly) with some of the highest free cash flow margins among the Mag 7:

  • Operating cash flow of $15.35 billion represents a margin of 58.9% which expanded 690 bps QoQ from 52% and expanded 18.4 points in the year ago quarter.
  • Free cash flow of $14.94 billion represents a margin of 57.3%, which was up 660 bps and is up 20.5 points YoY.

The company has $31.4 billion in cash and $9.71 billion in debt.

Nvidia announced a ten-for-one stock split, which will be effective June 6th, 2024. Trading will commence on a split-adjusted basis at market open Monday, June 10th, 2024.

Nvidia is increasing its cash dividend by 150% from $0.04 per share to $0.10 per share of common stock. The increased dividend is equivalent to $0.01 per share on a post-split basis. This quarter, the company utilized cash of $7.8 billion towards shareholder returns, including $7.7 billion in share repurchases and $98 million in cash dividends.

Key Segments:

Data center revenue of $22.6 billion, was up 427% YoY and up 23% QoQ. This marks an annualized run rate of $90 billion. We made the argument in today’s Forbes analysis that we could see a $200 billion data center segment by the close of FY2026 based on the strength of the Blackwell architecture, which would represent 65% upside from current analyst data center estimates. This requires speculation, of course, but management did state this in the call: “Blackwell will be available in over 100 OEMs at launch nearly double compared to Hopper, and will support broad and fast deployments.”

Management’s Q2 guide implies data center revenue of about $24 billion next quarter. This is assuming $4 billion from the other four segments, which reported a combined $3.5 billion this quarter. The CFO stated all segments would be up in Q2 on QoQ basis: “We expect sequential growth in all market platforms.”

  • Gaming reported revenue of $2.65 billion, which was up 18% YoY yet is down 8% QoQ. The company said the following in the opening remarks: “GeForce RTX GPUs, now with over 100 million installed base, gamers, creators and AI enthusiasts, unmatched performance for Gen AI on PCs.”
  • ProViz revenue of $427 million, was up 45% YoY and down 8% QoQ
  • Automotive was up 11% YoY and up 17% QoQ
  • OEM and other revenue of $78 million was up 1% YoY but down 13% QoQ.

Earnings Call:

One of the key points in the earnings call was the ROI that cloud service providers will see from renting GPUs. This may have been provided to help shine some light on why capex budgets continue to grow.

“For every $1 spent on NVIDIA AI infrastructure, cloud providers have an opportunity to earn $5 in GPU instant hosting revenue over four years. NVIDIA's rich software stack and ecosystem and tight integration with cloud providers makes it easy for end customers up and running on NVIDIA GPU instances in the public cloud.”For every $1 spent on NVIDIA AI infrastructure, cloud providers have an opportunity to earn $5 in GPU instant hosting revenue over four years. NVIDIA's rich software stack and ecosystem and tight integration with cloud providers makes it easy for end customers up and running on NVIDIA GPU instances in the public cloud.”

“For example, using Llama 3 with 700 billion parameters, a single NVIDIA HGX H200 server can deliver 24,000 tokens per second, supporting more than 2,400 users at the same time. That means for every $1 spent on NVIDIA HGX H200 servers at current prices per token, an API provider serving Llama 3 tokens can generate $7 in revenue over four years.”That means for every $1 spent on NVIDIA HGX H200 servers at current prices per token, an API provider serving Llama 3 tokens can generate $7 in revenue over four years.”

The company also went out of its way to highlight that they are well diversified beyond major cloud providers by pointing out that: “Large cloud providers continue to drive strong growth as they deploy and ramp NVIDIA AI infrastructure at scale and represented the mid-40s as a percentage of our Data Center revenue.” They highlighted that enterprises like Tesla and consumer internet companies like Meta are also strong growth verticals. Management also emphasized that it’s not only companies they have as customers, but also countries like Singapore and Japan.

When asked about why customers would continue to buy Hopper (if Blackwell is going to deliver 4X faster training and 30X faster inference), the answer was stated quite well:

Jensen Huang (CEO):

“If you're 5% into the build-out versus if you're 95% into the build out, you're going to feel very differently. And because you're only 5% into the build-out anyhow, you build as fast as you can. And when Blackwell comes, it's going to be terrific. And then after Blackwell, as you mentioned, we have other Blackwells coming. And then there's a short — we're in a one-year rhythm as we've explained to the world. And we want our customers to see our road map for as far as they like, but they're early in their build-out anyways and so they had to just keep on building, okay. And so there's going to be a whole bunch of chips coming at them, and they just got to keep on building and just, if you will, performance average your way into it. So that's the smart thing to do. They 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.”

Conclusion:

Over the past three days I’ve written 6,000 words on Nvidia. The goal was to get us prepared no matter the reaction to the earnings report. Rather than write a new conclusion, I will simply restate the one I published this morning, which is that Nvidia has sold off 10% or greater about 9 times since the 2022 low. We see any dips as buying opportunities as we brace for Blackwell toward the end of this year.

To read more on Blackwell, reference the analysis: “Nvidia Q1 Earnings Preview: Blackwell And The $200B Data Center”Nvidia Q1 Earnings Preview: Blackwell And The $200B Data Center”Nvidia Q1 Earnings Preview: Blackwell And The $200B Data Center”

Recommended Reading:

Nvidia Q1 Earnings: “We will see a lot of Blackwell revenue this year.”

Posted on by io-fund

Nvidia impressed again with a beat this quarter and a raise next quarter. However, that wasn’t enough to move the stock price. It was during the earnings call that we saw the stronger price action when management discussed the Blackwell architecture. The first question on the call was a direct question on when Blackwell will be in production:

Q: “So this year, we will see Blackwell revenue, it sounds like?”

A: The CEO offered one, simple sentence in a measured tone: “We will see a lot of Blackwell revenue this year.”

The call could have probably ended there as that one simple sentence shed light on what has been the predominant concern — can Blackwell keep up with Hopper. If you read my analysis published in Forbes this morning, then you know that the I/O Fund thinks a $200 billion data center segment is in sight by the end of CY2025.

There were other bullish comments about Blackwell ramping this year, such as “We will be shipping [Blackwell]. Well, we've been in production for a little bit of time. But our production shipments will start in Q2 and ramp in Q3, and customers should have data centers stood up in Q4.” This was strong language to use as it’s quite clear that Hopper has runway left given the beat/raises we saw in this quarter. To have the two architectures merge seamlessly in terms of timing in H2 is quite ideal.

Revenue and EPS:

Revenue of $26 billion is up 18% QoQ and up 262% from the year ago quarter. This means Q4 was officially the peak quarter for revenue growth, which we covered previously. Revenue beat expectations by 5.9% with analysts expecting $24.6 billion in revenue for growth of 242% YoY.

Nvidia will now face tougher comps as it laps Hopper’s impact from last year. The company is off to a decent start by forecasting next quarter revenue of $28 billion. Analysts were expecting $26.84 billion. This represents growth of 107% up from growth of 98.8% expected.

The intra-quarter revisions are particularly strong. However, regardless of ongoing upward revisions, it’s unlikely we return to the peak growth we saw in Q4 and Q1 (current quarter).

  • GAAP EPS of $5.98 compares EPS of $4.93 last quarter. This represents QoQ earnings growth of 21.3% and YoY earnings growth of 629%.
  • Adjusted EPS of $6.12 beat estimates of $5.58. This represents growth of 18.6% QoQ and 461% growth YoY.

Margins:

As expected, margins have expanded across the board.

  • GAAP gross margin of 78.4% compares to 64.6% in the year ago quarter, up 13.8 points YoY and up 240 bps from last quarter. This represents gross profit of $20.94 billion.
  • We will see a softening in gross margin due to a deceleration from peak revenue. Management is guiding for GAAP gross margin of 74.8% for next quarter with added color that the full year gross margins “are expected to be in the mid-70% range.”
  • Adjusted gross margin of 78.9% compares to 66.8% in the year ago quarter, up 12.1 points YoY and 220 bps from last quarter. Management is guiding for adjusted gross margin of 75.5%. This represents adjusted gross profit of $21.1 billion.
  • GAAP operating margin of 64.9% compares to 50.3% in the year ago quarter. This represents operating profit of $16.9 billion.
  • For next quarter, GAAP OPM is expected to soften to 60.5%, according to management’s guidance.
  • Adjusted operating margin of 69.3% was reported for Q1, representing adjusted operating profit of $18.05 billion.
  • For next quarter, adjusted operating margin is expected to soften to 65.5%.
  • Net margin this quarter was 57.1% compared to 28.4% in the year ago quarter, and was up 150 basis points QoQ. This represents net profit of $14.9 billion. The adjusted net margin this quarter was 58.5%.

Cash Flow:

Cash flow was strong (unsurprisingly) with some of the highest free cash flow margins among the Mag 7:

  • Operating cash flow of $15.35 billion represents a margin of 58.9% which expanded 690 bps QoQ from 52% and expanded 18.4 points in the year ago quarter.
  • Free cash flow of $14.94 billion represents a margin of 57.3%, which was up 660 bps and is up 20.5 points YoY.

The company has $31.4 billion in cash and $9.71 billion in debt.

Nvidia announced a ten-for-one stock split, which will be effective June 6th, 2024. Trading will commence on a split-adjusted basis at market open Monday, June 10th, 2024.

Nvidia is increasing its cash dividend by 150% from $0.04 per share to $0.10 per share of common stock. The increased dividend is equivalent to $0.01 per share on a post-split basis. This quarter, the company utilized cash of $7.8 billion towards shareholder returns, including $7.7 billion in share repurchases and $98 million in cash dividends.

Key Segments:

Data center revenue of $22.6 billion, was up 427% YoY and up 23% QoQ. This marks an annualized run rate of $90 billion. We made the argument in today’s Forbes analysis that we could see a $200 billion data center segment by the close of FY2026 based on the strength of the Blackwell architecture, which would represent 65% upside from current analyst data center estimates. This requires speculation, of course, but management did state this in the call: “Blackwell will be available in over 100 OEMs at launch nearly double compared to Hopper, and will support broad and fast deployments.”

Management’s Q2 guide implies data center revenue of about $24 billion next quarter. This is assuming $4 billion from the other four segments, which reported a combined $3.5 billion this quarter. The CFO stated all segments would be up in Q2 on QoQ basis: “We expect sequential growth in all market platforms.”

  • Gaming reported revenue of $2.65 billion, which was up 18% YoY yet is down 8% QoQ. The company said the following in the opening remarks: “GeForce RTX GPUs, now with over 100 million installed base, gamers, creators and AI enthusiasts, unmatched performance for Gen AI on PCs.”
  • ProViz revenue of $427 million, was up 45% YoY and down 8% QoQ
  • Automotive was up 11% YoY and up 17% QoQ
  • OEM and other revenue of $78 million was up 1% YoY but down 13% QoQ.

Earnings Call:

One of the key points in the earnings call was the ROI that cloud service providers will see from renting GPUs. This may have been provided to help shine some light on why capex budgets continue to grow.

“For every $1 spent on NVIDIA AI infrastructure, cloud providers have an opportunity to earn $5 in GPU instant hosting revenue over four years. NVIDIA's rich software stack and ecosystem and tight integration with cloud providers makes it easy for end customers up and running on NVIDIA GPU instances in the public cloud.”For every $1 spent on NVIDIA AI infrastructure, cloud providers have an opportunity to earn $5 in GPU instant hosting revenue over four years. NVIDIA's rich software stack and ecosystem and tight integration with cloud providers makes it easy for end customers up and running on NVIDIA GPU instances in the public cloud.”

“For example, using Llama 3 with 700 billion parameters, a single NVIDIA HGX H200 server can deliver 24,000 tokens per second, supporting more than 2,400 users at the same time. That means for every $1 spent on NVIDIA HGX H200 servers at current prices per token, an API provider serving Llama 3 tokens can generate $7 in revenue over four years.”That means for every $1 spent on NVIDIA HGX H200 servers at current prices per token, an API provider serving Llama 3 tokens can generate $7 in revenue over four years.”

The company also went out of its way to highlight that they are well diversified beyond major cloud providers by pointing out that: “Large cloud providers continue to drive strong growth as they deploy and ramp NVIDIA AI infrastructure at scale and represented the mid-40s as a percentage of our Data Center revenue.” They highlighted that enterprises like Tesla and consumer internet companies like Meta are also strong growth verticals. Management also emphasized that it’s not only companies they have as customers, but also countries like Singapore and Japan.

When asked about why customers would continue to buy Hopper (if Blackwell is going to deliver 4X faster training and 30X faster inference), the answer was stated quite well:

Jensen Huang (CEO):

“If you're 5% into the build-out versus if you're 95% into the build out, you're going to feel very differently. And because you're only 5% into the build-out anyhow, you build as fast as you can. And when Blackwell comes, it's going to be terrific. And then after Blackwell, as you mentioned, we have other Blackwells coming. And then there's a short — we're in a one-year rhythm as we've explained to the world. And we want our customers to see our road map for as far as they like, but they're early in their build-out anyways and so they had to just keep on building, okay. And so there's going to be a whole bunch of chips coming at them, and they just got to keep on building and just, if you will, performance average your way into it. So that's the smart thing to do. They 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.”

Conclusion:

Over the past three days I’ve written 6,000 words on Nvidia. The goal was to get us prepared no matter the reaction to the earnings report. Rather than write a new conclusion, I will simply restate the one I published this morning, which is that Nvidia has sold off 10% or greater about 9 times since the 2022 low. We see any dips as buying opportunities as we brace for Blackwell toward the end of this year.

To read more on Blackwell, reference the analysis: “Nvidia Q1 Earnings Preview: Blackwell And The $200B Data Center”Nvidia Q1 Earnings Preview: Blackwell And The $200B Data Center”Nvidia Q1 Earnings Preview: Blackwell And The $200B Data Center”

Recommended Reading:

Amazon Stock: Nearing $2 Trillion Club From AWS Growth & Ads Catalyst

Posted on by io-fund

This article was originally published on Forbes on May 17, 2024,09:37am EDTForbesForbes on May 17, 2024,09:37am EDT

Amazon shares have climbed to fresh all-time highs following a double beat in the last earnings report. The company is on the verge of joining the $2 Trillion Club, driven by a 4-percentage point accelerating in AWS to 17% YoY growth combined with strong 25% growth in advertising revenue. AWS surpassed a $100 billion annualized run rate in the first quarter, with management noting that they “see more absolute dollar growth again quarter-over-quarter in AWS than we can see elsewhere.”

E-commerce is what Amazon is famous for, however, it’s AWS and advertising that are the core growth engines. This past quarter, the two combined for $37 billion in high-margin revenue. Analyst estimates point toward AWS and advertising exiting 2024 at a combined $160 billion revenue run rate. If this materializes, these segments will combine for one-quarter of Amazon’s total revenue while helping to drive 221% YoY growth in operating income.

The synergies from strong double-digit advertising growth, an AI-driven acceleration in AWS, and an increasing cash flow margin support Amazon’s push to all-time highs. Plus, there are hints that the acceleration could continue as more GPU supply comes online, and as Amazon Prime implements ads in Prime Video.

Q1 Recap

Revenue of $143.3 billion beat estimates by $0.8 billion, marking the fourth consecutive quarter of double-digit growth as Amazon’s revenue growth rate accelerated 310 bp YoY to 12.5%. EPS increased 216% YoY to $0.98, as Amazon continued to realize gains from improved operating leverage, with gross profit rising more than 53% YoY and operating income surging 221% YoY to $15.3 billion.

Amazon’s North America segment and AWS both contributed to this operating income growth. North America operating income increased more 500% to $5.0 billion, from $0.9 billion last year; AWS generated $9.4 billion in operating income, up 84% YoY (and a 37.6% margin). Put another way, AWS contributed more than 61% of Amazon’s total operating income in the quarter despite contributing less than 18% of Amazon’s revenue.

Not only is Amazon showing an ability to expand its gross margin from less than 15% towards 20% in 4 quarters, but it’s also driving more pronounced growth in operating margin, reaching double-digits for the first time. 

Amazon Gross, Operating Margins

Pictured Above: Amazon reaches double digit operating margin for the first time. Source: I/O Fund

The tangible improvements to the bottom line are evident as the growth story unfolds. High-margin AWS and advertising revenues are also Amazon’s two fastest growing segments.

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AWS Seeing AI-Powered Growth

AWS re-accelerated 4 percentage points to 17% YoY growth in the quarter, as CEO Andy Jassy attributed it partly due to the “combination of companies renewing their infrastructure modernization efforts and the appeal of AWS’s AI capabilities.”

Growth has cooled rather dramatically since early 2022, where AWS was reporting growth rates above 30%, but at a $100B+ scale, AWS is driving the largest absolute dollar growth across the entirety of Amazon’s businesses.

Amazon is not providing a distinct breakout of AI’s contribution like Microsoft Azure, yet CEO Jassy commented that AWS is seeing “considerable momentum on the AI front, where we've accumulated a multi-billion-dollar revenue run rate already.”

AWS Quarter Revenue, Operating Income Growth

AWS re-accelerated 4 percentage points to 17% YoY growth in the quarter, while operating income grew 84% YoY. Source: I/O Fund

In Q1, we saw evidence that AWS is benefiting from strong demand for generative AI offerings with management optimistic that increased capex will continue to bear fruit in terms of growth. Interestingly, operating expenses for AWS declined YoY, from $16.2 billion to $15.6 billion, aiding this growth in operating income.

In addition, rival Microsoft explicitly pointed out that Azure does not have the GPU capacity to meet demand, Amazon also implied that demand is possibly higher than capacity of both third-party GPUs from Nvidia as well as for its custom silicon. Management noted that in the quarter, they “continued to meet growing demand for AWS Trainium and Inferentia chips,” and explained that a “meaningful” YoY increase in capex in 2024 is being driven by high generative AI demand.

One comment in particular hints at possible capacity constraints: “given the way the AWS business model works, [the capex increase] is a positive sign of the future growth. The more demand AWS has, the more we have to procure new data centers, power, and hardware.”

Reading between the lines here implies that Amazon is working to improve availability of its in-house Trainium and Inferentia chips while also expanding its data center infrastructure and purchasing more GPUs to continue to meet high demand gen AI demand. The end result is that AWS will likely accelerate again in future quarters as supply comes online.

A Note on Capex

Amazon did not provide a full-year figure for capex, but management is anticipating a meaningful YoY increase this year, primarily to support AWS’ growth. Q1’s capex was $14 billion, which management expects will also “be the low quarter for the year.” This suggests 2024’s capex could easily top $60 billion, exiting the year in the mid-$60 billion range or higher, representing a YoY increase of at least 24%.

We’re closely tracking Big Tech’s capex plans for 2024 and how this will flow downstream to AI hardware companies. We shared more than half a dozen reports and pre- and post-earnings updates on a handful of AI beneficiaries with our premium members. Learn more here.here.

Advertising Revenue Growth Remains Strong

Advertising is Amazon’s fastest growing segment with 24% YoY growth to $11.8 billion in revenue in Q1 and its rapidly scaling. Amazon recorded its first $10B ad revenue quarter in Q4 2022, and now has reported four quarters in a row above $10B.

On a TTM basis, advertising revenue was just shy of $50 billion, a 51% increase from $32 billion just two years ago. At this rate, Amazon is set to exit 2024 with ad revenues approaching $58 billion annually. Though Amazon does not break out advertising’s operating income like it does other segments, it says it “remains an important contributor to profitability in North America and International segments.” This is primarily made from sponsored ads on Amazon’s e-commerce site and the recent addition of sponsored TV ads, including on Thursday Night Football.

It’s also worth noting that ad-tech typically has some of the best margins in the tech industry, exceeding cloud or e-commerce.

Amazon Ad Revenue

Source: I/O Fund

Analysts are already quite optimistic about the revenue trajectory and potential for Prime Video ads which launched in January of this year. For reference, Netflix reported 23 million monthly active users (MAUs) globally a little over one year after it launched. Amazon is taking a different approach to SVOD ads than Netflix, Disney and others – instead of offering a cheaper, ad-supported tier, Amazon is adding ads to all Prime Video members, and offering an ad-free plan for an additional $3/mo.

By putting ads directly in front of an estimated 150+ million viewers, Amazon can benefit both from ad revenue and incremental revenue from subscribers who pay the ad-free upcharge. Bank of America analysts estimate that Amazon could rake in $3 billion in advertising revenue this year from Prime Video, potentially up to $5 billion when including those users who pay the additional charge. Morgan Stanley is a bit more optimistic about Amazon’s new initiative forecasting $3.3 billion this year, $5.2 billion in 2025 and $7.1 billion in 2026, generating an additional $2.3 billion in EBITDA in 2024. We see a more conservative take from MoffetNathanson, which projects just $1.3 billion in ad revenue this year before rising to $2.3 billion in 2025, with ~$500 million from users paying the ad-free upcharge.

Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, as well as various stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.

Unlocking Value via AWS, Ads

AWS and advertising are poised to exit 2024 at a combined $160 billion annualized run rate, or ~25% of Amazon’s estimated FY24 revenue. The two segments may help unlock more value for Amazon, given the gross and operating margin expansion the two segments are driving.

Take AWS – at $100 billion plus ARR, it’s the largest cloud provider compared to Azure at $76 billion ARR, Google Cloud at $38 billion and Oracle at $20 billion. Though AWS’ growth is lower at 17% versus >25% for rivals, it has one of the strongest margin profiles, with a 37.6% operating margin in Q1 and a 30.6% TTM operating margin.

Hyperscalers' Cloud Operating Margins

AWS has one of the strongest margin profiles among rival hyperscalers, with a 37.6% operating margin in Q1 and a 30.6% TTM operating margin. Source: I/O Fund

In a sum-of-the-parts view, AWS could be worth $900 billion: this assumes a fair ~9x sales multiple, or a 30x earnings multiple, given that AWS may potentially generate a ~50% YoY increase to ~$30 billion in net income on a 75% YoY increase in operating income towards $40 billion. These multiples are conservatively in-line with current market valuations in cloud and AI – Microsoft trades at 13x forward sales and 33x forward earnings for 17% company wide growth, and Oracle at 6x forward sales and 21x forward earnings for single-digit growth.

Turning to ads, as the segment approaches a $60 billion run rate by the end of the year, it could fetch a $360 billion value in a similar sum-of-the-parts look. With growth likely remaining above 20%, this is again a conservatively fair market multiple of 6x forward sales, compared to a 7.6x forward sales multiple for Meta and a 6x forward sales multiple for Google.

Combined, Amazon’s two fastest growing segments could be viewed as worth at least $1.26 trillion, while also driving significant gross margin and operating margin expansion. When combined with Amazon’s remaining e-commerce and subscription businesses, which could be worth $1.2 trillion at a 2.5x multiple (a 30% discount to Amazon’s 5-year average 3.3x multiple) on an estimated ~$480 billion in revenue in 2024, there is room for Amazon’s valuation to expand towards the $2.5 trillion threshold. However, this outlook is reliant on AWS maintaining this revenue acceleration, as well as ads & AWS driving continual margin expansion.

Valuation Intact, Strong Cash Flow Growth

Amazon’s valuation is not at peak levels, with shares trading far below historical highs, unlike Microsoft which is trading at ‘Mount Everest’ valuations in regards to historical valuation multiples.

Amazon currently trades in line with its 5-year average PS ratio of nearly 3.4x, and at about 3.1x forward PS — although this is a significant increase from the 1.6x multiples at the start of 2023, Amazon’s forward PS ratio is 10% lower than early 2022.

Amazon PS Ratio

Source: YCharts

Due to strong growth on the bottom line, Amazon is cheap on PE basis for this stock. The current PE Ratio of 52 is one of the lowest we’ve seen in the past few years, and is comfortably below the 3-year median of 67 and the 5-year median of 78. In fact, Amazon is cheaper now than it was in October 2023, despite a nearly 60% rally in shares since then.

Amazon PE Ratio

Due to strong growth on the bottom line, Amazon is cheap on a PE basis for this stock. Source: YCharts

Earnings growth and operating cash flow growth are both expected to be strong in 2024 and extend into 2025. Amazon is estimated to report more than 56% growth in EPS this year to $4.52 before rising another 27% to $5.74 in 2025. Operating cash flow is projected to increase 45.5% to $123.6 billion in 2024 before rising another 19% to $147.4 billion in 2025.

Conclusion

In a 2022 webinar entitled “The New Kings of Tech,” our firm discussed that the first wave of AI gains will be realized in the enterprise space. We also recently debated on Real Vision that Big Tech has an undeniable advantage in AI due to possessing the capital to make the required hardware investments, and having an immediate product-market fit with their current in-house segments. Meanwhile, mid cap companies and small startups have to find customers for their AI products, and those SMB customers must be willing to absorb the high costs of AI. Meanwhile, Amazon is well positioned to capitalize on surging generative AI demand quickly with a multi-billion dollar run rate in AWS from AI products already. Combined with advertising, the two are driving strong margin expansion and aiding in both top and bottom-line growth; and in turn, this growth is creating an attractive valuation on the bottom line.

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Big Tech Q1 Earnings: AI Capex Increases As AI-Related Gains Continue

Posted on by io-fund

This article was originally published on Forbes on May 9, 2024,02:23pm EDTForbes on May 9, 2024,02:23pm EDT

Recent Q1 earnings releases from Microsoft, Amazon, Alphabet and Meta reaffirmed that AI spending is continuing to increase through 2024 as companies seek AI-related revenue gains.

The tech giants are continuing to dedicate tens of billions each towards AI infrastructure, and overall were broadly optimistic over the opportunities that generative AI brings to growth and the value that these AI services provide to end customers. Below, we take a look at Big Tech’s Q1 earnings, AI commentary and capex plans for 2024, and what this means for the broader AI industry.

Q1 Earnings: AI Aids Revenue Gains

Big Tech’s reported revenue growth rates in Q1 were higher than anticipated just over two quarters ago. Meta is seeing one of the largest accelerations at 10 percentage points due to accelerating advertising revenue as ad prices recover. Microsoft is reporting one of the largest AI contributions of 7 points within Azure, which helped raise estimates by 550 bps. Across the board, however, Big Tech is accelerating which is not merely a coincidence.

Big Tech Revenue Growth Acceleration

Source: I/O Fund, Company Filings

Microsoft beat on the top and bottom line with $61.85 billion in revenue, representing a second straight quarter with revenue growth above 17% YoY. This is the first time it’s been above 17% in two years. This was driven by 21% growth in Intelligent Cloud, and in that, an acceleration to 31% growth in Azure, with 7 percentage points from AI.

Recall that in our Big Tech Stocks: Q3 Earnings Preview from October, prior to Microsoft’s September quarter report (which saw AI’s first contributions to Azure’s growth), Microsoft was expected to see 10% to 11.5% revenue growth these past two quarters – at this revenue scale, up to a 6 percentage point acceleration in three quarters marks an inflection point. For a more in-depth look at Microsoft’s recent earnings report, read the analysis: “Microsoft Fiscal Q3: 80% YoY Increase in Capex; Azure AI is Hitting Capacity”Big Tech Stocks: Q3 Earnings Preview from October, prior to Microsoft’s September quarter report (which saw AI’s first contributions to Azure’s growth), Microsoft was expected to see 10% to 11.5% revenue growth these past two quarters – at this revenue scale, up to a 6 percentage point acceleration in three quarters marks an inflection point. For a more in-depth look at Microsoft’s recent earnings report, read the analysis: “Microsoft Fiscal Q3: 80% YoY Increase in Capex; Azure AI is Hitting Capacity”

Alphabet easily beat Q1 revenue and EPS estimates as both Google Cloud (GCP) and Search revenue growth accelerated, combined with strong YouTube revenue growth. Overall revenue growth was 15.4% in Q1, the fastest in two years, and a strong acceleration from just 2.6% growth in the year ago quarter. Similar to Microsoft, increasing contributions from AI in GCP and resilient Search and YouTube ad revenues has resulted in revenue growth that is nearly 4 percentage points higher than Q1’s 11.8% growth estimate from October.

Meta reported 27.3% revenue growth and a solid EPS beat in Q1, as it captured tailwinds from 20% growth in ad impressions combined with 6% growth in ad prices. The ad impressions have cooled from 30% growth in mid 2023. Revenue gains were strongest in Rest of World and Europe at nearly 42% and 34% YoY, as Meta capitalized on double-digit growth in ad prices in those regions. While AI is aiding with improved ROI and automation for advertisers, Meta struck a nerve as it downplayed near-term revenue recognition from increased AI investments and the stock sold off nearly 11% after the earnings report.

Amazon rounded out the double beats from Big Tech as it notched a top and bottom line beat due to a 4-percentage point acceleration in AWS sales to 17% YoY and strong 24% growth in advertising revenue. AWS surpassed a $100 billion annualized run rate in the first quarter, with management noting that they “see more absolute dollar growth again quarter-over-quarter in AWS than we can see elsewhere.”

Microsoft, Meta, Alphabet and Amazon are reporting significant YoY improvements in operating margin, with Meta recording the largest expansion at 13 percentage points.

Source: Company Filings

We’re also seeing the four Big Tech companies report significant YoY improvements in operating margin, with Meta recording the largest expansion at 13 percentage points. Amazon’s operating margin improved 7 percentage points from an increase in AWS’ operating margin to 38%, which was up 14 percentage points. Cost management efforts combined with improvements in operating leverage, aided by AI growth and efficiency gains, can help the four Big Tech companies maintain and drive full-year operating margin expansion.

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Management Positive About AI’s Potential

Management teams from The Four offered positive commentary about AI’s potential to drive new growth. On the earnings call, it was discussed that AI can help to improve ROI for advertisers, help drive more infrastructure revenue (already seen in beats from Azure, GCP, and AWS), plus AI will help to innovate across customer-facing applications.

Let’s dig in to some of the top quotes and stats shared from each management team.

Microsoft:

Microsoft shared some of the more impressive (and arguably most important) stats around AI, with CEO Satya Nadella providing multiple strong growth rates for AI products and insights into AI demand.

He noted that Azure Arc now has “33,000 customers, up over 2X year-over-year,” while the “number of 100 million dollar-plus Azure deals increased over 80% year-over-year, while the number of 10 million dollar-plus deals more than doubled.”

GitHub Copilot now has “1.8 million paid subscribers, with growth accelerating to over 35% quarter-over-quarter” and revenue growth of 45% YoY. In terms of device penetration, “Copilot in Windows is now available on nearly 225 million Windows 10 and Windows 11 PCs, up 2X quarter-over-quarter.”

However, one of the most important pieces was that Microsoft’s current “near-term AI demand is a bit higher than our available capacity,” meaning its available GPU supply is not enough to meet demand from customers. Read more here.

Meta:

After launching its newest AI assistant powered by its Llama 3 model in mid-April, Meta CEO Mark Zuckerberg said the “initial rollout of Meta AI is going well. Tens of millions of people have already tried it.” He later added that he believes “Meta AI with Llama 3 is now the most intelligent AI assistant that you can freely use.”

Zuckerberg also noted that “about 30% of the posts on Facebook feed are delivered by our AI recommendation system. That's up 2x over the last couple of years. And for the first time ever, more than 50% of the content people see on Instagram is now AI recommended.”

In terms of how AI is aiding revenue, CFO Susan Li explained that “with our core AI work, we continue to have a very ROI-driven approach to investment, and we're still seeing strong returns as improvements to both engagement and ad performance have translated into revenue gains.”

Alphabet:

Alphabet CEO Sundar Pichai said that Google has “already served billions of queries with our generative AI features” while also “seeing an increase in Search usage among people who use the new AI overviews, as well as increased user satisfaction with the results.”

In addition, he added that “more than 60% of funded gen AI startups and nearly 90% of gen AI unicorns are Google Cloud customers,” and “more than one million developers are now using our generative AI across tools including AI Studio and Vertex AI.”

Amazon:

Amazon also shared some impressive stats about AI tool adoption as well as its revenue contribution, with CEO Andy Jassy saying that Amazon sees “considerable momentum on the AI front, where we've accumulated a multi-billion dollar revenue run rate already.” Microsoft is similarly in the multi-billion dollar range in Azure, where the 7% boost to growth is correlating to an approximate $4 billion run rate.

CFO Brian Olsavsky added that AWS has surpassed a $100 billion run rate and that’s “before you even calculate gen AI, most of which will be created over the next 10 to 20 years from scratch and on the cloud.”

Amazon’s managed end-to-end service SageMaker is aiding in LLM training, AI inference, and productivity improvements, with management stating that “Perplexity AI trains models 40% faster in SageMaker [and] Workday reduces inference latency by 80% with SageMaker.”

We recently entered an AI hardware stock to capitalize on Big Tech’s surging capex and GPU purchases, and may soon make it our highest allocation in our portfolio, with premium members receiving real-time trade alerts on this stock and the rest of our portfolio. Learn more about our premium memberships here.here.

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Capex Surging More Than 35% YoY In 2024

Big Tech will likely commit upwards of $200 billion, maybe even $210 billion, combined in capex this year, predominantly for AI infrastructure – from data center construction and expansion, to GPU procurement and custom silicon efforts and more.

It’s no wonder the four are boosting capex by more than 35% YoY, given positive outlooks on AI’s potential to drive revenue growth in the billions and how demand continues to outstrip GPU supply. Overall, capex commentary from the four was directionally bullish for AI semiconductors and server manufacturers, though Meta’s vagueness on a timeline to recognize a return on said spend hit shares quite hard.

Microsoft:

Microsoft increased its capex 80% YoY to $14 billion this quarter, and for the entire fiscal year, capex will increase approximately 50% YoY to more than $50 billion. Demand for Azure’s AI services is outpacing its capacity in the near-term, hence the need for Microsoft to accelerate spending to boost GPU supply. It has been reported that Microsoft is seeking to triple its GPU supply this year to 1.8 million GPUs.

Alphabet:

Alphabet’s capex rose 91% YoY to $12 billion in Q1, primarily for technical infrastructure – this capex spend was led by servers and followed by data centers. Management is expecting quarterly capex “to be roughly at or above the Q1 level,” implying a full-year capex around $50 billion, an increase of ~55% YoY. Management said this significant growth in capex “reflects our confidence in the opportunities offered by AI across our business.”

CFO Ruth Porat explained that “as we’re investing in CapEx and applying it across our various businesses, it opens up more service and products, which bring revenue opportunities, and we’re very focused on the monetization opportunity,” which spans Search, Cloud, YouTube, and other services. CEO Sundar Pichai emphasized that Alphabet has “clear paths to AI monetization through Ads and Cloud, as well as subscriptions.”

Meta:

Meta boosted its full year capex range to $35-40 billion, pointing to 33% YoY growth and $4 billion more than previously anticipated, to build out AI infrastructure and support its internal AI roadmap. Meta’s Q1 capex was only $6.7 billion, implying that the bulk of this spend will hit in the second half of the year, possibly accelerating at a ~20% QoQ rate and exiting 2024 above the $11 billion range. However, despite these aggressive investments in AI, Meta was rather vague on its returns, saying it is very early on the return curve:

As we're scaling capex and energy expenses for AI, we'll continue focusing on operating the rest of our company efficiently. But realistically, even with shifting many of our existing resources to focus on AI, we'll still grow our investment envelope meaningfully before we make much revenue from some of these new products.

Once our new AI services reach scale, we have a strong track record of monetizing them effectively. There are several ways to build a massive business here, including scaling business messaging, introducing ads or paid content into AI interactions, and enabling people to pay to use bigger AI models and access more compute.”

Despite the hints of positivity in creating and monetizing new services, the commentary highlights a rather important angle that the market does not like – an unclear timeline to when a return on increased investments will be recognized. This is quite the polar opposite from Microsoft and Amazon, who have multi-billion dollar AI revenue streams that will immediately benefit from increased expenditures on capacity expansion. The difference is that AWS and Azure are more enterprise or startup related whereas Meta is more consumer related. It’s been our contention that AI is an enterprise technology first and foremost when we held a webinar in 2022 when it was stated about AI that: “enterprises are going to drive forward the gains over the next 10 years, it will not be consumer.”

Amazon:

Amazon did not provide a full-year figure for capex, but management said they anticipate capex will “meaningfully increase year-over-year in 2024, primarily driven by higher infrastructure CapEx to support growth in AWS, including generative AI.” In addition, they expected the $14 billion capex sum for Q1 will “be the low quarter for the year,” suggesting capex could easily top $60 billion, exiting the year in the mid-$60 billion range or higher, an increase of at least 24% YoY.

CEO Andy Jassy explained this capex growth is driven by “the combination of AWS' reaccelerating growth and high demand for gen AI, … which given the way the AWS business model works is a positive sign of the future growth. The more demand AWS has, the more we have to procure new data centers, power and hardware.”

Implications For the Broader AI Industry

This increased spending by Big Tech ultimately is flowing to multiple core components for infrastructure expansion and increased GPU capacity. Management teams are talking about more GPU purchases, more custom silicon buildout, data center expansion, and the need for more hardware (networking and switches). For example, since the start of this year, consensus revenue estimates for Nvidia have already risen from $91 billion at the beginning of January to $112 billion at the beginning of May – an increase of $21 billion. This goes hand in hand with its new GPU releases and increased Big Tech spending.

However, AI opportunities extend well past Nvidia. We’ve been closely monitoring Big Tech for years while identifying the top beneficiaries from this blistering AI-driven increase in capex. We routinely share our research with our premium members including how this impacts AI semiconductors such as GPUs and custom silicon, memory players, and AI networking.

If you own AI stocks, or are looking to own AI stocks, we encourage you to attend our weekly premium webinars, held every Thursday at 4:30 pm EST. Next week, we will discuss a handful of AI plays for 2024 – what our targets are, where we plan to buy as well as take gains. Learn more about I/O Fund’s premium services here.

I/O Fund Equity Analyst Damien Robbins contributed to this report.

Recommended Reading:

Alphabet Q1 2024: Impeccable Earnings Report, GCP Accelerates from AI

Posted on by io-fund

Alphabet’s revenue accelerated for the sixth consecutive quarter. Revenue grew by 15% and clocked the fastest growth since Q1 2022. Google Cloud revenue accelerated for the second consecutive quarter. The company also announced its first dividend and authorized a new $70 billion share repurchase plan. The margin improvement due to the cost reduction initiatives was the icing on the cake. The shares closed 10% higher following strong results and reached the $2 trillion market capitalization milestone.

Revenue

Revenue grew by 15% and 16% in constant currency YoY to $80.54 billion and beat estimates by 2.3%. Revenue accelerated for the sixth consecutive quarter. Analysts expect revenue to grow 12.5% YoY to $83.90 billion in the June quarter. While growth is decelerating, the consensus estimates have moved up 100 basis points compared to the estimates prior to the earnings.

Google Services segment revenue grew by 14% YoY to $70.4 billion. Search and other advertising revenues accelerated  to 14% YoY growth to $46.2 billion from 13% in the December quarter and 11% in the September quarter, which was primarily due to strong growth in retail, particularly from APAC-based retailers. The strong trend in the advertising business from APAC-based retailers began in Q2 2023 last year and continued in the recent quarter.

Management also highlighted tougher comps in the upcoming quarter and headwinds from the strong dollar. “As we look ahead, two points that will affect sequential year-on-year revenue growth comparisons across Alphabet. First, Q1 results reflect the benefit of leap year, which contributed slightly more than one point to our revenue growth rate at the consolidated level in the first quarter. Second, at current spot rates, we expect a larger headwind from foreign exchange in Q2 versus Q1.”

Margins

The company’s cost control initiatives, such as workforce reductions and office space optimizations, have helped the company report very strong margins in the recent quarter. Going forward, management expects operating margin for 2024 to be higher than in 2023. This is from moderating expense growth for higher depreciation and expenses related to higher technical infrastructure investments.

  • Gross margin expanded 200 basis points YoY and 160 basis points QoQ to 58.1%.
  • Operating margin expanded 660 basis points YoY and 410 basis points sequentially to 31.6%. Non-GAAP operating margin, which excludes severance and related office space charges, came in at 32.5% compared to 28.6% in the same period last year.
  • The operating margin was the second highest in the previous 10 years, and if we exclude the non-recurring charges in the recent quarter, it is the highest in the last decade.

Ruth Porat, CFO of the company said in the earnings call:

“Turning to margins, our efforts to durably re-engineer our cost base are reflected in a 400 basis point expansion of our Alphabet operating margin year-on-year, excluding the impact of restructuring and severance charges in both periods. You can also see the impact in the quarter-on-quarter decline in headcount in Q1, which reflects both actions we have taken over the past few months and a much slower pace of hiring. As we have discussed previously, we are continuing to invest in top engineering and technical talent, particularly in Cloud, Google DeepMind, and technical infrastructure. Looking ahead, we remain focused on our efforts to moderate the pace of expense growth in order to create capacity for the increases in depreciation and expenses associated with the higher levels of investment in our technical infrastructure. We believe these efforts will enable us to deliver full-year 2024 Alphabet operating margin expansion relative to 2023.”

–End Quote

Net margin improved 780 basis points YoY and 540 basis points sequentially to 29.4%. GAAP EPS came in at $1.89, up 61.5% YoY and beat estimates by 25%. It partly benefitted from a net gain on equity securities of $2.2 billion, and the $104 million reversal of previously accrued performance fees related to some of these investments, which increased net income by $1.9 billion and EPS by $0.15.

Analysts expect the company to report GAAP EPS of $1.83 in the next quarter, up from expectations of $1.69 prior to the earnings report.

Cash Flows and Balance Sheet

Operating cash flow was $28.85 billion or 35.8% of revenue compared to $23.51 billion or 33.7% in the same period last year. Free cash flow was $16.84 billion or 20.9% of revenue compared to $17.22 billion or 24.7% in the same period last year. Free cash flow was lower than the previous year as capex increased 91% YoY to $12 billion due to AI.

The CFO said in the earnings call, “With respect to CapEx, our reported CapEx in the first quarter was $12 billion, once again driven overwhelmingly by investment in our technical infrastructure with the largest component for servers followed by data centers. The significant year-on-year growth in CapEx in recent quarters reflects our confidence in the opportunities offered by AI across our business. Looking ahead, we expect quarterly CapEx throughout the year to be roughly at or above the Q1 level, keeping in mind that the timing of cash payments can cause variability in quarterly reported CapEx.”

This means that capex is expected to rise about 49% YoY to $48 billion in 2024.

Cash and marketable securities were $108.09 billion compared to $110.92 billion in the December quarter. Debt was also largely unchanged at $13.23 billion compared to $13.25 billion in the December quarter.

Another key highlight in the report was the announcement of the first quarterly dividend of $0.20 and the authorization of an additional $70 billion share repurchase plan. The company repurchased shares worth $15.7 billion in the recent quarter.

Key Metrics:

Google Cloud Revenue

Google Cloud revenue grew by 28% YoY to $9.6 billion, helped by increasing contributions from AI and strong Workspace growth, which is productivity apps. The revenue growth accelerated for the second consecutive quarter from 26% in the previous quarter and 22% in the September quarter. The strong growth also further helped to narrow the gap with Microsoft Azure’s growth of 31%. Google Cloud now only trails Microsoft Azure by 3 percentage points compared to 4 points and 7 points in the previous two quarters.

The operating margin for Google Cloud came in at 9% compared to 3% in the same period last year and 9% in the December quarter.

Google Advertising Revenue

Google Advertising revenue accelerated for the fifth consecutive quarter. Revenue grew by 13% YoY to $61.7 billion, compared to 11% growth in the December quarter, and was flat in the same period last year.

  • Google Search and other advertising revenues grew by 14% YoY to $46.2 billion. It was up from 13% growth in the previous quarter and 2% in the same period last year.
  • YouTube ads revenue grew by 21% YoY to $8.09 billion, helped primarily by direct response marketing and brand advertising. It was up from 16% growth in the previous quarter and a decline of (-3%) in the same period last year.
  • Networking advertising revenue declined by (-1%) YoY to $7.41 billion. It was better than the (-2%) decline in the previous quarter and (-8%) decline in the same period last year.

Earnings Call:

Capex

Big Tech capex has surged over the past few quarters and Google is no exception.

Capex grew 91% YoY to $12 billion; this is up from 45% growth and $11 billion last quarter. As stated, this means that capex is expected to rise about 49% YoY to $48 billion in 2024.

The CFO stated less than 10% was going to office with the rest going toward infrastructure (or AI basically).

Per the earnings call:

Ruth Porat:

“And then in terms of CapEx, as I said in opening comments, we do expect the quarterly CapEx throughout the year to be roughly at or above the $12 billion cash CapEx we had here in Q1. As I said, you can always have variability in the reported quarterly CapEx just due to the timing of cash payments, but roughly at or above this level. And it really goes to Sundar's comment, opening comment, that we're very committed to making the investments required to keep us at the leading edge in technical infrastructure to support the growth in Cloud, all the innovation and search that he and Philip have spoken about and our lead with Gemini. I will note that most nearly all, I should say, of the CapEx was in our technical infrastructure. We expect that our investment in office facilities will be about less than 10% of the total CapEx in 2024, roughly flat with our CapEx in 2023, but is still there […]

Clear Path to Monetization

In the call, the CEO highlighted six points as to why the company is positioned to tap the AI opportunity.

  1. Leadership position in R&D
  2. Infrastructure leadership including Google Cloud
  3. The company invests in developing new AI models; custom TPUs power AI projects which are in the 5th generation and this powers Search
  4. Global product footprint
  5. Velocity in execution (my note: this one can lag at times)
  6. Monetization paths

Of these, the last one on monetization paths interests us the most.

Regarding #4, the global product footprint combined with infrastructure leadership (#2) will help with data sovereignty in the medium-term as AI will become required to have data residency in the country the data is produced. This isn’t unique necessarily as all hyperscalers offer this, but it’s notable and supports our thesis that Big Tech will get Bigger.

The clear path to monetization that Google speaks about is through Google Cloud, which accelerated this quarter and is closing the gap with juggernaut Azure. Secondly, it’s through Search revenue and ad revenue on YouTube and its advertising network. As stated above, Google Cloud accelerated to 28% growth, up from 26% growth in the previous quarter. Search also accelerated to 14% growth this quarter for revenue of $46.2 billion, compared to growth of 13% and revenue of $48 billion last quarter (seasonal high due to being Q4). These are record quarters for Search revenue.

Per the opening remarks – note, SGE refers to Google Search Generative Experience (SGE) which uses gen AI to provide brief overviews of web pages.

“We have clear paths to AI monetization through ads and cloud, as well as subscriptions. Philip will talk more about new AI features that are helping advertisers, including bringing Gemini models into Performance Max. Our Cloud business continues to grow as we bring the best of Google AI to enterprise customers and organizations around the world. And Google One now has crossed 100 million paid subscribers. And in Q1, we introduced a new AI premium plan with Gemini Advanced […]

“You can see that from the increases in our capital expenditures. This will fuel growth in cloud, help us push the frontiers of AI models, and enable innovation across our services, especially in Search. AI innovations and Search are the third and perhaps the most important point I want to make. We have been through technology shifts before, to the web, to mobile, and even to voice technology. Each shift expanded what people can do with Search and led to new growth. We are seeing a similar shift happening now with generative AI. For nearly a year, we have been experimenting with SGE and Search labs across a wide range of queries. And now we are starting to bring AI overviews to the main Search results page. We are being measured in how we do this, focusing on areas where gen AI can improve the Search experience, while also prioritizing traffic to websites and merchants.

We have already served billions of queries with our generative AI features. It's enabling people to access new information, to ask questions in new ways, and to ask more complex questions. Most notably, based on our testing, we are encouraged that we are seeing an increase in Search usage among people who use the new AI overviews as well as increased user satisfaction with the results.”

–End Quote

Later, the CFO added: “We're continuing to experiment with new ad formats, including search and shopping ads alongside search results in SGE. And we shared in March how folks are finding ads either above or below the SGE results helpful. We're excited to have a solid baseline to keep innovating on and confident in the role SGE, including ads, will play in delighting users and expanding opportunities to meet user needs.”

Toward the end of the call, an analyst asked the CEO to quantify the monetization. He did not provide specifics, rather stated: “There are questions about monetization, and based on our testing so far, I am comfortable and confident that we'll be able to manage the monetization transition here well as well.”

My note: there is a lot of corporate-speak on these calls to wade through. However, to keep it brief and direct, areas where Google can continue to monetize Search is on mobile with rumours that Apple may partner with Google’s Gemini to power AI apps on iPhones in the future. Android also currently has 3 billion users that Gemini can reach.

60% of Funded Gen AI Startups use Google Cloud

Google Cloud has the majority of funded AI startups building on Google Cloud. Although this is too small to make a revenue impact, the message is that Google Cloud is at the cutting edge for AI workloads training on Nvidia’s GPUs and its own TPUs. Google also recently announced Axion CPUs.

 “Today, more than 60% of funded Gen AI startups and nearly 90% of Gen AI unicorns are Google Cloud customers […] We also announced Axion, our new Google design and ARM-based CPU. In benchmark testing, it has performed up to 50% better than compatible x86-based systems. On top of our infrastructure, we offer more than 130 models, including our own models, open source models, and third-party models. We made Gemini 1.5 Pro available to customers, as well as Imagine 2.0 at Cloud Next.”

It was also stated that over 1 million developers use Google’s generative AI tools.

Google Third-Party Cookie Deprecation

Google has delayed the third-party cookie deprecation on its browser for the third time with plans to now phase them out in 2025. As of now, it has restricted third-party cookies to only 1% of Chrome users. The delay is due to concerns from the regulatory authorities, particularly the UK’s Competition and Markets Authority (CMA) and the ad industry. The recent release said, “It's also critical that the CMA has sufficient time to review all evidence including results from industry tests, which the CMA has asked market participants to provide by the end of June.”

Regulators like the UK’s Competition and Markets Authority (CMA) have previously raised concerns that Google’s plan to replace third-party cookies with its Privacy Sandbox initiative will give Google an unfair advantage in the ad market. According to eMarketer and 33Across, cookies were used in 78% or more of programmatic ad buys. Google’s Privacy Sandbox replaces cookies with 20 different APIs for “Measurement and Relevance” and also “Other APIs” to help advertisers target users based on topics and cohorts without tracking individual behavior. For users and advertisers, this is an improvement from cookies. For competitors like The Trade Desk, this poses a threat as Google own major properties across the web, and theoretically, eliminating cookies can limit the effectiveness of a platform like The Trade Desk. This is because cookies leak a lot of data to third parties like The Trade Desk, whereas what Google seeks to do is stop those leaks to outside parties on their own properties (Chrome for now, Android soon after). 

Despite Google being the target for alleged monopolistic control over Search and its ad network, Apple and Mozilla have already phased out identifiers on their browsers, and Apple has also done this on iOS. We covered this extensively, including here. According to Google, Privacy Sandbox will use the same Android API solutions, and no one (including Google) will have a privileged position (given the recent allegations in the DOJ lawsuit, I’d take that with a grain of salt).

Ad-tech companies like The Trade Desk have been critical of Google’s Privacy Sandbox. We previously discussed this here. The Trade Desk is a solid resource on discussing the downside to deprecating cookies, as they are one of Google’s fiercest opponents in that regard. The Trade Desk has famously created an alternative for a consortium of first parties and third parties called Unified Ad ID or UID2.0. There is a long and impressive list of collaborators that have adopted UID2.0.

So, who better to turn to than Jeff Green for the most recent, unfiltered commentary from one of Google’s opponents. Here is what was stated on the most recent earnings call:

Brian Fitzgerald (Analyst)

Thanks. Jeff, it looks like third-party cookies won't be going away now for at least until '25. What are your thoughts on the cookie deprecation delay once again and how, if at all, it impacts the industry? And then, maybe secondarily, could you — could the continued delays have any impacts, positive or negative on UID2.0 adoption?

Jeff Green (CEO, The Trade Desk)

[…] I think it is a strategic mistake for Google to deprecate cookies. I don't think the risk/reward is worth it for them. And I would not be surprised to see them delay this again and again as they continue to buy more time. I think that's exactly what we saw because we weren't surprised by this, we predicted this. We have just been sort of quick to move on. I do want to give Google a little bit of credit though. I mean, Apple took away cookies and said nothing, gave no announcement, offered no alternatives. Google said we're going to take away cookies, they gave some head start. Now, they moved the date a bunch, both forward and backward, which to me didn't make any sense. But they did at least try to propose something else, which was a privacy sandbox. The unfortunate thing was what they proposed was half-fake and not a valid solution. And so, the industry has just been criticizing it, us included, for the better part of the year because those criticisms, I think, were pretty unanimous even from industry bodies like the IAB that I never expected to take such a strong position on privacy sandbox. I think it forced Google's hand to delay cookie deprecation. So we were not surprised by it. The net effect of that is that it gives the open Internet a bit more runway to adopt things like UID2 and come up with authentication and identity strategies so that they can thrive in an environment outside of cookies.  […]

And so, I think the average publisher is saying exactly what we were saying four or five years ago that while we think it's a strategic mistake for Google to get rid of cookies, we also think it's a strategic mistake for all the rest of us to do nothing.”

–End Quote

Google’s Antitrust Lawsuit to be Decided in Q3

We’ve covered the antitrust lawsuit in the past here when we stated: “Therein lies the issue. Google undisputedly has the world’s best consumer data, but did this grow to become part and parcel with operating a monopoly? The Department of Justice has asserted anti-trust violations against Google with the trial beginning in September 2023 […]  This is not a headline to simply dismiss. It’s the first time the DOJ has brought a case of this kind against a technology company since Microsoft. If there are even minor cracks in Google’s monopoly, there could stand to be a stock or two that starts a new trajectory.”

Of course, the stock that starts the new trajectory could be Google if the DOJ rules in their favour. The trial is now concluded, and in his closing arguments, U.S. District Judge Amit Mehta questioned whether another company could rival Google’s search due to the cash and data that the company possesses, especially with Google’s 90% market share as a search engine in the crosshairs. The company pays $20 billion to make its search engine the default across Apple and Mozilla browsers and devices. Google argues they are widely used because of large R&D investments, which has made their technology superior. In cases where other search engines were the default, users complained or manually switched on their own.

The decision is expected to be announced in late summer or early fall.

Conclusion

Alphabet delivered a perfect earnings report. It beat the top line and bottom line; plus important key metrics are accelerating. Google Cloud revenue accelerated for the second consecutive quarter, narrowing the gap with Microsoft Azure. The dividend announcement was welcomed to help Google meet pressures from the Street.  

Meanwhile, Alphabet has a tough year ahead with pushback from the deprecation of cookies in the early part of 2025 (assuming there are no further delays), and the looming decision from the DOJ on the antitrust trial. We continue to believe this is a landmark case for a tech company, and requires a bit of a gamble on how it will turn out for Google.

We’ve covered Alphabet extensively on AI, as well. You can find previous analysis here:

AMD Q1 Earnings: GPU Revenue Outlook Raised to $4B

Posted on by io-fund

AMD reported an in-line quarter on both revenue and EPS, with data center revenue coming in just above $2.3 billion for 80% YoY growth and a slight 2% QoQ increase. Margins were stable, with management guiding for a slight 100 bp QoQ expansion in adjusted gross margin. Cash flows improved sequentially, with AMD posting strong double-digit QoQ growth in both operating and free cash flow.

AMD’s GPU revenue forecast was boosted by ~14%, with management now seeing full year revenues at $4 billion, compared to its prior view for $3.5 billion plus. However, analyst expectations were largely pointing to $4 billion as the ‘minimum’ figure, with some looking for GPU revenue as high as $8 billion. The raise is welcomed with MI300 cumulative sales surpassing $1 billion since the launch in Q4, however, it’s not enough to meet a wide range of heightened expectations.

Below, we breakdown the glass half-full or glass-half empty psychology that is overshadowing AMD’s accomplishments right now (and which side of the proverbial debate we are on, and why).

Revenue and EPS:

  • Q1 revenue was $5.47 billion, marginally ahead of expectations for $5.45 billion and representing YoY growth of 2.2%.
  • Q2 revenue was guided at $5.7 billion, +/- $300 million for YoY growth of approximately 6% and QoQ growth of 4%. This was in line with consensus estimates for $5.69 billion.
  • Q1’s adjusted EPS was $0.62 in line with estimates for $0.61, representing YoY growth of 3%. GAAP EPS was $0.07 which missed estimates of $0.17 EPS.
  • Q2 estimates from analysts are for $0.69 EPS in the June quarter and $1.00 in the September quarter.

Key Segments:

Data Center:

AMD had guided for Q1 data center revenue to be approximately flat QoQ, implying revenues around $2.3 billion for YoY growth of ~77%. The company reported data center revenue of $2.34 billion, up 80% YoY.

AMD says the YoY growth was “driven by growth in both AMD Instinct™ GPUs and 4th Gen AMD EPYC™ CPUs,” and the sequential growth was “driven by the first full quarter of AMD Instinct GPU sales, partially offset by a seasonal decline in server CPU sales.” AMD added that MI300 cumulative revenues have surpassed $1 billion since launching in Q4 2023, signaling strong initial adoption and an ability to quickly ramp production.

The CFO guided for next quarter: “Sequentially, we expect data center segment revenue to increase by double-digit percentage, primarily driven by the data center GPU ramp.” Later it was stated: “In the second quarter, we expect overall data center to be up strong double digits.”

An analyst offered verbal math of $900 million for GPU sales next quarter, to which the CFO simply stated she was not guiding to those details. For our purposes, this is a good number to go with. The company called out Microsoft, Meta and Oracle as customers.

Regarding EPYC CPUs, on the call, an analyst stated that his math points toward AMD’s CPU server sales declining 5-6% which is considered strong compared to a competitor (likely Intel). “It looks like your server CPU business was also down at the lower end of the seasonal range. By my math, it was down like 5%, 6% sequentially. Is that right? And that's less than half the decline of your competitor?”

Per the opening remarks: “Given our high core count and energy efficiency, we can deliver the same amount of compute with 45% fewer servers compared to the competition, cutting initial CapEx by up to half and lowering annual OpEx by more than 40%” and also: “We believe we gained server CPU revenue share in the seasonally down first quarter led by growth in enterprise adoption and expanded cloud deployments.”

Client, Embedded, Gaming:

Client segment revenue increased 85% YoY to $1.37 billion, driven predominantly by Ryzen 8000 series processor sales. Revenues declined just (6%) sequentially for the segment.

For Q2, it was stated that Client revenue would increase QoQ.

Per the opening remarks: “Looking forward, we believe the market is on track to return to annual growth in 2024, driven by the start of an enterprise refresh cycle and AI PC adoption. We see AI as the biggest inflection point in PC since the Internet with the ability to deliver unprecedented productivity and usability gains.”

Embedded segment revenue was $846 million, declining (46%) YoY and (20%) QoQ as customer inventory management continued.

For next quarter, the CFO stated Embedded would be flat QoQ, which implies a (47%) decline in Q2. The weakness is coming from automotive, which is widespread.

Gaming revenue was $922 million, declining (48%) YoY and (33%) QoQ “due to due to a decrease in semi-custom revenue and lower AMD Radeon GPU sales.” Looking forward, gaming is expected to decline by a “revenue to decline by significant double-digit percentage.” It was later stated on the call that gaming would be down a “similar zip code” as Q1. In the Q&A, it sounded like this won’t improve this year.

Per the CFO:

“If you look at the gaming, the demand has been quite weak, that's quite very well known and also their inventory level. So based on the visibility we have, the first half both Q1, Q2, we guided down sequentially more than 30%. We actually think the second half will be lower than first half that's basically how we're looking at this year for the gaming business.”

Margins:

Margins for the first quarter were in line with management’s expectations, while Q2’s guide implied a 1 percentage point expansion in adjusted gross margin, driven by an increase in data center mix and lower gaming revenue as gaming has a lower margin than DC.

  • GAAP gross margin was 47%, unchanged from Q4 but up 300 bp from 44% in the year ago quarter. Adjusted gross margin was 52%, in line with management’s guidance, and representing a 100 bp QoQ and 200 bp YoY expansion. Increased data center and client revenues and lower gaming revenue aided the margin expansion.
  • GAAP operating margin was 1% in Q1, an improvement from (-3%) in the year ago quarter but down from 6% in Q4. Adjusted operating margin was 21%, flat YoY and down 200 bp QoQ.
  • On a segment view, data center operating margin was 23.1%, an 1170 bp YoY expansion but a 620 bp QoQ contraction, likely driven by efforts to ramp up MI300 GPU production.
  • Notably, the MI300s are lower than the “corporate gross margin” right now but is expected to be above corporate gross margin over time. For full year 2021, the gross margin was 48%, so that’s a good benchmark for a best-case scenario GM.  Per the CFO: “It's the GPU gross margin right now is below the data center gross margin level. I think there are 2 reasons — actually, the major reason is we actually increased the investment quite significantly to, as Lisa mentioned, to expand and accelerating our road map in the AI side, that's one of the major drivers for the operating income coming down slightly. On the gross margin side, going back to your question, we said in the past and we continue to believe the case is. Data center GPU gross margin over time will be accretive to corporate average, but it will take a while to get to the server level for gross margin.”
  • GAAP net margin was 2%, an improvement from (1%) in the year ago quarter but down from 11% in Q4. Adjusted net margin was 19%, unchanged from Q4 and up slightly from 18% in the year ago quarter.
  • For Q2, management guided adjusted gross margin of 53%, implying a 100 bp QoQ and 300 bp YoY expansion.
  • For Q2, adjusted operating margin is expected to be ~21% given management’s guidance for $1.8 billion in operating expenses.

Cash and Debt:

AMD’s cash flow improvements stood out in Q1’s in line report, as the company drove significant double-digit sequential growth in cash flows and margin improvements.

  • Operating cash flow was $521 million in Q1, an increase of 7.2% YoY and 36.7% QoQ. Operating cash flow margin was 10%, a 300 bp sequential improvement.
  • Free cash flow was $379 million in Q1, an increase of 15.5% YoY and 56.6% QoQ. Free cash flow margin was 7%, a 300 bp sequential improvement.
  • AMD reported cash and equivalents of $6.04 billion.
  • Debt was unchanged at $2.47 billion.

Earnings Call:

AMD’s AI Revenue Ramp: Glass Half-Full or Glass Half-Empty

AMD is an interesting case of is the glass half-full or is the glass half-empty. Interviews like this one, from an analyst that closely follows the stock, would cause you to believe the glass is half-empty. From the reaction after hours, it would be hard to tell that the primary segment reported 80% YoY growth and is expected to grow strong double digits sequentially.

My take is that the glass is 30% full and will likely exit the year half-full. Per the call, one analyst’s math is for $900M in GPUs next quarter. If we take $2.4 billion for the DC segment this quarter and assume strong double-digit growth, that puts us at a $3B data center segment next quarter (roughly). If this analyst’s math is correct, this means within two quarters of shipping; GPUs will be 30% of DC segment in Q2. I can’t think of another company that has ramped this fast outside of Nvidia. Broadcom has had ASICs revenue for years from Google’s TPUs (maybe 2018-ish) so we aren’t looking at as fast of a ramp there.

AMD is in Nvidia’s shadow with GPU revenue, and understandably so, given Nvidia is commanding a $80B annual data center segment (on its way to a $100B segment). Therefore, AMD stock is up against some hefty investor psychology with its tiny $10B segment (roughly).

However, if we zoom-out, sometime in 2025, CPU revenue will be eclipsed by GPU revenue. We were looking at about a $1.7B-ish segment on CPUs prior to the MI300 release for the Frontier supercomputer in Q4. Whenever GPUs exceed $7B in revenue, they will have officially passed up AMD’s CPUs, which took almost 10 years to build that kind of revenue (first gen EPYC was released in 2014). Meanwhile, AMD’s CPU trajectory resulted in 1700% gains in stock price due to flawless execution against Intel. Meaning, that was a breathtaking 10 years.

Now, I’m not saying this will translate to the exact same gains as the CPU comeback story — but by my estimation, doing what took 10 years in as brief as 2 years (with a long runway to go) should translate to something.

$4B in AI Revenue but Vague as To the Exit Rate

Management left room for a higher exit rate this year in terms of AI revenue. There was nothing said concretely but there were some subtle hints that we will hear a higher exit rate in the coming quarters. This was the most pointed discussion in that regard:

Question
Vivek Arya (Analysts)

Lisa, I just wanted to go back to the supply question and the $4 billion outlook for this year. I think at some point, there was a suggestion that the $4 billion number, right, that there are still supply constraints. But I think at resent point, you said that you have supply visibility significantly beyond that. Given that we are almost at the middle of the year, I would have thought that you would have much better visibility about the back half. So is the $4 billion number of supply constrained number? Or is it a demand constrained number? Or relatively, if you could give us some sense of what the exit rate of your GPU sales could be. I think on the last call, $1.5 billion was suggested. Could it be a lot more than that in terms of your exit rate of MI for this year?

Answer
Lisa Su (Executives)

Yes. Vivek, let me try to make sure that we answered this question clearly. From a full year standpoint, our $4 billion number is not supply capped — I'm sorry, yes, it's not supply cup. It is — we do have supply capability above that. It is more back half weighted. So if you're looking at sort of the near term, I would say, for example, in the second quarter, we do have more demand than we have supply right now, and we're continuing to work on pulling in some of that supply. By the way, I think this is an overall industry issue. This is not at all related to AMD. I think overall, AI demand has exceeded anyone's expectations in 2024. So you've heard it from the memory guys. You've heard it from the foundry guys. We're all ramping capacity as we go through the year. 

And as it relates to visibility, we do have good visibility into what's happening. As I said, we have great customer engagements that are going forward. My goal is to make sure that we pass all of the milestones as we're ramping products. And as we pass those milestones, we put that into the overall full year guidance for AI. But in terms of how customer progression things are going, they're actually going quite well, and we continue to bring new customers on and we continue to expand workloads with our current customers. And so hopefully, that clarifies the question, Vivek.

The Concerning Rumor about Microsoft:

No doubt, the main thing that needed to be cleared was the Microsoft rumor that we detailed in our pre-earnings report. I agree and appreciate the tone of this question, as there is never-ending noise with AMD, and am quoting it in full:

Question
Matthew Ramsay (Analysts)

I appreciate that, Lisa. As my follow-up, a little bit shorter term. And I guess having followed the company super closely for a long time. I think there's been — there's always been noise in the system from whether the stock price is $2 a share or $200, there's been kind of always consistent noise with the other. But the last 1.5 months has been extreme in that sense. And so I wanted to just — I got random reports by inbox about changes in demand from some of your MI300 customers or planned demand for consuming your product. I think you answered earlier about the supply situation and how you're working with your partners there. But has there been any change from the customers that you're in ramp with now or that you soon will be of what their intention is for demand? Or in fact, has that maybe strengthened rather than gone down in recent periods because I keep getting questions about it?

Answer
Lisa Su (Executives)

Sure, Matt. Look, I think I might have said it earlier, but maybe I'll repeat it again. I think the demand side is actually really strong. And what we see with our customers and what we are tracking very closely is customers moving from, let's call it, initial POCs to pilots to full-scale production to deployment across multiple workloads. And we're moving through that sequence very well. I feel very good about the deployments and ramps that we have ongoing right now. And I also feel very good about new customers who are sort of earlier on in that process. So from a demand standpoint, we continue to build backlog as well as build engagements going forward. And similarly, on the supply standpoint, we're continuing to build supply momentum. But from a speed of ramp standpoint, I'm actually really pleased with the progress.

–End quote

My take is that all corporate executives are trained to smooth things over, so we can’t tell from this answer if Microsoft truly canceled orders to some effect or not. But the overall message is that demand outstrips supply.

Conclusion:

If I were to guess, we are hitting up against valuation concerns which are being waved off with conversations on CNBC and elsewhere that AI revenue isn’t materializing fast enough. This simply isn’t true.

However, AMD is expensive — all semis are expensive — and we’ve been here before. This is not our first rodeo when the market doubts a company and comes up with outlandish narratives when it simply hits a valuation ceiling.

Seeing the forest through the trees is important because we need to put our ducks in a row on how to manage our portfolio given these valuations are high, yet these stocks are driving forward a massive market unlike anything we’ve seen before (compare EPYC CPUs ramp to Instinct GPUs ramp — it’s very clear we are in unchartered territory with the growth of AI).

A few weeks ago (and again after hours), AMD retested and broke support for the bullish count of $158. We are looking for AMD to hold $138 and will likely add here. Notably, a break below $128 is more concerning but this report should be enough to avoid that scenario. We will keep you updated in our weekly webinars and with real-time trade alerts as we carefully manage this high-conviction position.

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