Broadcom is firing on all cylinders and this earnings report cemented the company as number two in terms of AI revenue. It’s not only the AI revenue that sets Broadcom apart, but also its developing software strategy with VMWare.
The headline numbers don’t help to translate underlying AI strength as Broadcom reiterated its full year guidance yet raised AI revenue. This is because some of Broadcom’s segments are coming in lower than expected, while AI is coming in higher than previously guided.
This comment kicked off the tone of the call: “I know we told you in December, our revenue from AI would be 25% of our full year semiconductor revenue. We now expect revenue from AI to be much stronger, representing some 35% of semiconductor revenue at over $10 billion.” This is up from $7.5 billion expected this year, and also up from a $6 billion run rate last quarter ($1.5B per quarter). The AI revenue is roughly 70% ASICs and 30% AI Networking.
In addition to stronger-than-expected AI revenue, Broadcom is expecting dramatic, sequential growth in software bookings, which are expected to grow about 70% QoQ. We need another quarter or two to verify if the rapid growth from VMWare Cloud Foundation will continue, but management implies it will continue to be strong. If so, Broadcom is quickly asserting itself as a leader in AI software as consolidated bookings are expected to add $1.2 billion QoQ from $1.8 billion this quarter to $3 billion next quarter.
Financials Overview:
Revenue and EPS:
- Q1 revenue was $11.96 billion, beating estimates by $240 million, and representing YoY growth of 34%. Excluding VMWare, revenue growth was 11% for a 7 percentage point acceleration over the past two quarters, at 4% in the October quarter and 4.9% growth in the July quarter.
- Q4 adjusted EPS was $10.99, beating estimates by $0.57. GAAP EPS was $2.84, compared to $8.80 in the year ago quarter.
- Broadcom reiterated its fiscal year revenue guide of $50 billion and full year EBITDA guidance of 60%. This compares to an EBITDA margin of 63% to 65% in previous quarters.
Margins:
- Q1 GAAP gross margin was 61.7%, compared to 67.4% in the year ago quarter. Amortization of acquisition-related intangible assets adversely impacted gross margin by ~1150bp in the quarter. Adjusted gross margin was 75.4%, compared to 73.8% in the year ago quarter.
- Q1 GAAP operating margin was 17.4%, compared to 46% in the year ago quarter. The operating margin was mainly lower due to the increase of amortization of acquisition-related intangible assets, restructuring charges, and stock-based compensation. Adjusted operating margin was 57.1%, compared to 60.9% in the year ago quarter.
- Q1 GAAP net margin was 11.1%, compared to 42.3% in the year ago quarter. The net margin was mainly lower due to the increase of amortization of acquisition-related intangible assets, restructuring charges, and stock-based compensation. Adjusted net margin was 43.9%, compared to 50.3% in the year ago quarter.
Cash and Debt:
- Q1 operating cash flow was $4.82 billion, representing a 40.3% margin.
- Q1 free cash flow was $4.69 billion, representing a 39.2% margin. Excluding restructuring and integration spend of $658 million, free cash flow was 45% of revenue.
- Cash, equivalents and short-term investments totaled $11.9 billion.
- Debt totaled $75.9 billion. The debt increased from the $39.2 billion in the previous quarter due to the additional debt taken to finance the VMware purchase and the company also assumed $8.3 billion VMware’s debt. We had discussed this in our deep-dive here. The average coupon-rate and years to maturity of fixed rate debt of $48 billion is 3.5% and 8.4 years, respectively. The average coupon-rate and years to maturity of floating rate debt of $30 billion is 6.6% and 3 years, respectively. This week, the company repaid $2 billion of floating rate debt and intends to maintain this quarterly repayment throughout FY2024.
In Q1, Broadcom paid stockholders $2.4 billion of cash dividends based on a quarterly common dividend of $5.25 per share. The company repurchased $7.2 billion of common stock and eliminated $1.1 billion of common stock for taxes due on vesting of employee equity, resulting in the repurchase and elimination of approximately 7.7 million AVGO shares. The Q2 non-GAAP diluted share count is expected to increase to approximately 492 million as the shares issued including VMWare.
Days sales outstanding were 41 days in the first quarter compared to 31 days in the fourth quarter on higher accounts receivable due to the VMware acquisition. This is due to the accounts receivable from VMware having payment terms of 60 days compared to Broadcom’s 30 days.
The company ended the first quarter with inventory of $1.9 billion, up 1% sequentially.
Key Segments:
Software Revenue:
Management reiterated their software revenue guidance of $20 billion this year.
- Q1 Software segment revenue of $4.6 billion was up 156% year-on-year and included $2.1 billion in revenue contribution from VMware. In the previous quarter, software was $1.97 billion. This implies 27% QoQ growth in software after stripping out VMWare. When asked about this, management said to not get too excited about this particular growth as it’s due to strong contract renewals. Instead, the CEO explicitly stated: “Yes, don't get too excited over that. So that has also accelerated, but that's not the star of this show, Stacy. Star this show is the accelerating bookings and backlog we are accumulating on VMware.” In fact, it was indicated that some of this could fall off in future quarters given the software guide was not raised.
- What the CEO is referring to as the star of the show is the consolidated bookings in software, which grew sequentially from less than $600 million to $1.8 billion in Q1 and is expected to grow to over $3 billion in Q2. Per management: “Revenue from VMware will grow double-digit percentage. Sequentially, quarter-over-quarter, through the rest of the fiscal year.”
Management stated the rapid growth from the VMWare segment is because: “We are focused on upselling customers, particularly those who are already running their compute workloads with vSphere virtualization tools to upgrade to VMware Cloud Foundation, otherwise branded as VCF […] VMware and NVIDIA entered into a partnership called VMware Private AI Foundation, which enables VCF to run GPUs. This allows customers to deploy their AI models on-prem. And wherever they do business without having to compromise on privacy and data — in control of their data. And we are seeing this capability drive strong demand for VCF, from enterprises seeking to run their growing AI workloads on-prem.”
We covered the VMWare acquisition recently in our Broadcom deep dive here.Broadcom deep dive here.
Semiconductor Revenue:
Semiconductor solution sales increased 4% YoY to $7.39 billion, a slight uptick from 3.3% growth in the prior quarter. Stronger-than-expected growth from AI more than offsetting the cyclical weakness in broadband and server storage. According to Bloomberg, this was a bit shy of expectations for $7.7 billion in revenue. This was most likely due to weak wireless, broadband, and server storage segments.
- Q1 networking revenue of $3.3 billion grew 46% year-on-year, representing 45% of semiconductor revenue. Management stated the following: “For fiscal 2024, given continued strength of AI NAND working demand, we now expect networking revenue to grow over 35% year-on-year compared to our prior guidance for 30% annual growth.”
- Q1 wireless revenue of $2 billion decreased 1% sequentially and declined 4% year-on-year representing 27% of semiconductor revenue. Wireless is expected to be flat YoY for FY2024.
- Q1 server storage connectivity revenue was $887 million or 12% of semiconductor revenue, down 29% year-on-year. The company revised its server storage revenue to decline in the mid-20 percentage range compared to prior guidance for a decline in the high teens.
- Broadband Q1 revenue declined 23% year-on-year to $940 million and represented 13% of semiconductor revenue. Broadcom revised its outlook for fiscal '24 broadband revenue to be down 30% year-on-year from prior guidance of down mid-teens year-on-year.
- Q1 industrial resales of $215 million declined 6% year-on-year. Management stated that industrial resales will be down high single digits this year.
Earnings Call:
Right out the gate, an analyst asked about the surprising acceleration in QoQ bookings on software. Because it’s QoQ, this isn’t accretive software growth from the acquisition (that’s the $600M to $1.8B), rather next quarter represents new, accelerated growth from $1.8B to $3B. The comment from management that “revenue from VMware will grow double-digit percentage. Sequentially, quarter-over-quarter, through the rest of the fiscal year’ helped to solidify that we are already seeing VMWare’s contribution accelerate. We need a few more quarters to figure out if this is a pull forward of some kind and to see where the growth rate will eventually settle. Certainly, it’s off to a promising start.
Question
Harsh Kumar (Analyst)
Once again, tremendous results and tremendous activity that you guys are benefiting from in AI. But my question was on software. I think if I heard you correctly, Hock, you mentioned that your software bookings will rise quite dramatically to $3 billion in 2Q. I was hoping that you could explain to us why it would rise almost 100% up, if my math is correct, in 2Q over 1Q. Is it something simple? Or is it something that you guys are doing from a strategy angle that's making this happen?
Answer
Hock Tan (Executive)
As I indicated, with the acquisition of VMware — we're very focused on selling, upselling and helping customers, not just buy but deploy this private cloud what we call virtual private cloud solution or platform on their on-prem data centers. It has been very successful so far. And I agree it's early innings still at this point. We just have closed on the deal — well, we closed on the deal late November, and we are now March, early March.
So we had the benefit of at least 3 months, but we have been very prepared to launch and focus on this push initiative on private cloud, VCF. And the results has been very much what we expect it to be, which is very, very successful.
This was also stated later in the call by the CEO:
“All that focus is on the largest, I would say, 2,000 strategic customers. These are guys who want to still have significant distributed data center on-prem […] today's environment, most of these customers do not have an on-prem data center that resembles what's in the cloud, which is very high availability, very low latency, highly resilient, which is one we are offering with VMware Cloud Foundation of VCF. It's exactly replicate what they get in a public cloud. And they love it. Now 3 months. But we are seeing it in the level of bookings we are generating over the last 3 months.”
Near the Semiconductor Trough
Regarding Broadcom’s underperforming segments, the company reiterated what was heard in the Marvell call that we are near the bottom.
Karl Ackerman (Analyst)
Hock, weakness in broadband, server and storage customers is understandable given what your peers have said this earnings season. But perhaps you could speak to the backlog visibility you have with your customers in those markets that would indicate those markets could begin to order again and see sequential growth in the second half through our calendar year?
Answer
Hock Tan (Executive)
You're correct. We are — as I say, we are almost like near the trough. This year, '24, first half, for sure, will be the trough. Second half 24, don't know yet. But I tell you what, we have 52-week lead time, as you know. We are very disciplined in sticking to it. And based on that, we are seeing bookings lately, significantly up from bookings a year ago.
Conclusion:
Broadcom’s PS valuation is quite high at 16 compared to the 3-year median of 8. The PE ratio of 42 compares to a 3-year median of 28.5. How to approach this position is not easy given the report was quite strong and there is reason to believe Broadcom will end this year with more beats/raises now that VMWare Cloud Foundation is rapidly accelerating and we already got a $2.5B raise in AI revenue. It’s likely we close Marvell tomorrow and re-allocate some to Broadcom, while taking our time to find an additional entry in the coming weeks.
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