Marvell reported in line with expectations. There was a miss on GAAP margin and GAAP EPS, yet the guide was in line. We had written in our pre-earnings writeup that GAAP margins were depressed due to the amortization of acquired intangible assets, and that management expected further challenges due to increased product mix of 5G and ASICs.
What’s exciting is that Marvell doubled its AI revenue from $400 million to $800 million. This means AI is now 14.4% of revenue, up from roughly 7% (on an annual run rate). This is bullish for our CY2024 thesis, and was not expected so soon. The most important statement on the call was this:
“Based on our latest demand outlook for our electro-optics products, we now expect revenue from AI to exit this year at over a $200 million quarterly revenue run rate or $800 million annualized. This is well above what we had outlined last quarter. Put this in perspective, this would put us at the run rate we had previously communicated for all of next year.”
Where the report is concerning is the increasing net debt to EBITDA ratio, which has increased from 1.6X to 1.8X. You can expect us to risk manage this position depending on FED actions. It was stated in the call: “we will opportunistically explore accessing the debt capital markets to refinance our upcoming debt maturities.”
Please note, we covered Marvell more in-depth yesterday heading into earnings, so this will be a brief update. Read more here.
Revenue and EPS:
- Revenue of $1.34 billion was in line. This represents a year-over-year decline of (-11.60%).
- Guide of $1.4 billion was in line. This represents a year-over-year decline of (-8.9%)
- GAAP EPS missed at (-$0.24) reported versus (-$0.15) EPS expected
- Adjusted EPS was in line at $0.40
Going into the report, we had said:
Margins:
- GAAP Gross Margin missed, hence the miss on GAAP EPS. The company reported 38.9% versus 45.6% guided, at the midpoint for a miss of 670 basis points.
- Adjusted gross margin was in line with guidance at 60.3%
- GAAP operating margin missed, coming in at (-15.3%) versus (-6.6%) expected. This resulted in an operating loss of (-$205.7) million
- Adjusted operating margin was marginally above expectations at 26.9% compared to 26.3% guided. This resulted in $360.1 million in adjusted operating profits
- The net margin was (-15.5%) and adjusted net margin was 21.6%
Cash:
The operating cash flow was $112.5 million compared to $208.4 million in Q1 and $332 million in the same quarter last year. The operating cash flow was low primarily due to an increase in DSO (days sales outstanding) and severance-related cash restructuring charges. Management mentioned that they expect DSO to improve in the next quarter.
The CFO, Willem Meintjes, replied to an analyst’s question.
“Yes, so this quarter certainly DSO was impacted somewhat by linearity. We do expect a nice back — bounce-back in Q3 and some normalization.”
It is crucial the company to improves its cash flows in the coming quarter. The free cash flow dropped to $1.2 million compared to $105.8 million in Q1 and $256.3 million in the same period last year. The lower operating cash flows and higher capex of $111 million led to the drop in the free cash flow.
Debt:
The company has cash of $423.4 million compared to $1.03 billion at the end of Q1. Debt is $4.15 billion, which includes short-term debt of $1.02 billion.
The company used $572 million to repay debt in the recent quarter. Due to the lower cash flows, the company had to repay its debt from the cash balance. This was in contrary to what management had indicated in the Q1 earnings call when they stated they would repay debt from free cash flow and cash balance.
They have resumed buybacks as indicated in the last earnings call and it doesn’t seem ideal the company would take this route when the net debt to EBITDA ratio has increased from 1.6x in Q1 to 1.83 in Q2.
Per the earnings call, “we will opportunistically explore accessing the debt capital markets to refinance our upcoming debt maturities.”we will opportunistically explore accessing the debt capital markets to refinance our upcoming debt maturities.”
We had highlighted this risk in our pre-earnings coverage that this is a stock we will be cautious with depending on the FED’s actions due to higher interest rate environment.highlighted this risk in our pre-earnings coverage that this is a stock we will be cautious with depending on the FED’s actions due to higher interest rate environment. If we close the position, it will be due to this as we foresee AI revenue becoming meaningful in the second half of calendar year 2024, and the FED becoming more meaningful than AI much sooner.
Also note, we were on high alert for comments around this per our pre-ER writeup, and the report did not satisfy the criteria of being able to pay the debt from cash flow.
Key Metrics:
Data center revenue was down (-29%) and was up 6% QoQ, which should be marking a bottom, as long as the storage recovery doesn’t get pushed out further. This compares to being down (-32%) YoY last quarter and (-12%) QoQ decline. This exceeded guidance of 0% QoQ growth. The beat was due to the AI networking products.
On a QoQ basis, data center is expected to accelerate to “mid-teens” growth. Per management: “Demand for our AI products continues to grow at an extraordinary rate and we are working very closely with our customers to meet the rapidly evolving needs. On the other hand, enterprise on-premise is expected to continue to trend down. As a result, we are projecting overall data center revenue in the third quarter to grow in the mid-teens sequentially on a percentage basis.”
This additional color was also shared: “Our overall revenue from cloud grew over 20% sequentially. Notably, revenue from both cloud AI and standard cloud infrastructure grew sequentially, with AI growing faster. As expected, revenue from the enterprise on-premise portion of our data center end market declined significantly on a sequential basis in the second quarter, reflecting a weakening enterprise market.”
Carrier infrastructure segment was down (-3%) YoY and down (-5%) QoQ due to wired networks whereas 5G was strong at 25% QoQ growth.
Enterprise networking declined (-4%) YoY and (-10%) QoQ. This is expected to decline further into the low teens QoQ next quarter. Per management, enterprise networking will take a few quarters to normalize: “We expect this inventory re-normalization to take a few quarters to resolve as customer balance sheets get worked down over time.”
Automotive was up 32% YoY and 23% QoQ driven by increased adoption of Ethernet in cars. This segment is expected to be up 30% YoY and flat sequentially.
Consumer end market is up 2% YoY and up 18% QoQ. Revenue is expected to grow sequentially next in the low teens next quarter.
Notes on AI Revenue:
Per our pre-earnings notes regarding AI revenue: “However, up until FY2023 ending in January, the revenue was $200 million. This revenue is expected to double in the current fiscal year 2024 to $400 million.”
Notably, the company is at a $800 million run rate now with this earnings report. So, this means AI revenue has already doubled from the last call. Yes, it’s doubling on small numbers but it looks like we will be crossing $1 billion soon, and where can we then reasonably assume Marvell will end next fiscal year 2025 (calendar year 2024)?
This is why AI is tricky – it moves very rapidly – so we went from 7% of revenue exiting the year at $400M in the last call to 14.4% of revenue exiting the year within three months. If Marvell adds $400 million again next one or two quarters, we will be at 18.3% of revenue based on the FY guide for FY2025.
What will the market do once we reach 30% or even 50% and how quickly will this happen. If we double between FY2024 to FY2025 (ending in calendar January 2025) then we will be at 25% of revenue by end of next year, or 18 quick months. This is based off adding another $800 million by end of year next year, which is a reasonable assumption since Marvell added $400 million annual run rate in a quarter. I’m sure you know where I’m going with this. Due to the rapid move in AI revenue this quarter, 25% in AI revenue exiting next year is probably too low.
Earnings Call:
Marvell said something on the call that has been my contention for some time, which is that there are “scarce few” companies that will enable AI. I believe this is a winner-takes-most market. This is why I like Marvell very much as a stock, it’s showing us in the very early innings that it can be one of the few contenders to enable AI.
“As you heard in detail last quarter, AI infrastructure requires a staggering amount of high-bandwidth connectivity, best provided by an optically connected infrastructure operating at the highest available speeds. Marvell is enabling AI with a broad range of solutions, which include: PAM4-based optical DSPs and AECs for connecting accelerator clusters inside AI data centers; DCI products for connectivity between regional data centers; low-latency high-capacity Ethernet switches for fabric connectivity inside data centers; and custom silicon for compute acceleration. We are confident that the breadth of Marvell's technology positions us as one of a scarce few semiconductor companies that can enable the industry to capitalize on the rapid growth in AI.”.
Also, per the call, the following was stated on the margins: “We're targeting to get back to that 64% exiting this year and then to maintain that through next year. But clearly, it's sort of early to decide exactly how big the ASIC ramp is next year. Now if we do show outsized growth there, that would negatively impact our gross margin, but certainly our view is that, that would be very accretive to operating income and to EPS.”
Of course, my focus is on the “how big the ASIC ramp is next year” — the market will likely be forgiving on margins if we get a nice surprise in this regard.
Conclusion:
As a gentle reminder, covering semis is not easy. It was one year ago to the month that Nvidia missed $2.5B in revenue and it was expected to take years for the company to overcome the crypto mining selloff from Ethereum’s merge to PoS.
Nvidia looks easy now that the company is reporting triple digit data center revenue growth, yet its gaming segment was a cyclical, black eye to the company in prior quarters. Thus, if you’re looking at this report and wondering if it’s worth sorting through all these moving pars, the answer (for me) is absolutely yes. The edge in investing is not found in regurgitating what everyone else already knows. Even if the Street is aware that Marvell has AI revenue, the company is greatly underestimated due to the rising importance of custom silicon.
In fact, the intense focus on Nvidia is perhaps to our favor as we will continue to dig up lesser-known stocks and AI angles. Marvell is a stock we’ve owned and covered for many years (about 3-4 years now), and it’ll take just a touch more patience before this research pays off on a company that is quite complex.
However, I don’t want to overlook the debt issue that Marvell faces. This simply doesn’t match our investing criteria and so in that regard we want to emphasize risk management around any FED decisions. If we were to close/trim, we will add back at appropriate technical levels. We are ignoring this discipline for now and remaining invested, but want to give our Members a heads up that this is a risk we are tracking.
& p.s. sorry for any typos – we are closing out a long week and a long earnings season at the I/O Fund! See you Monday.
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