Regarding the horizontal lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.

Elliott Wave counts are meant to provide context. Each colored count represents the most probable paths given the current price data. There is a pattern unfolding in real-time, one of which will play out. By monitoring price levels that are held/broken, it will help us figure out which one is in play, so that we can better manage risk.

Broad Market Technical Analysis

Price Analysis

When you funnel the global community of investor into a quantifiable arena, like the stock market, interesting and repeatable patterns emerge. These patterns are the basis of technical analysis, and are used by analysts to predict market trends and establish risk parameters. The discipline of Elliott Wave analysis is simply an in depth study of these repeatable patterns, which provides the best context to market behavior that I know of.

The fundamental idea is that markets move up in a 5 wave pattern, and once this 5 waves pattern completes, we then see a 3 wave retrace/correction, which will make a higher low. This simple movement is not only happening on all time frames, and in all markets where people interact to find price discovery, but it is fractal. So, a small 5 wave pattern develops into a larger one, which then develops into a larger one, and so on. 

Because of the fractal nature within market patterns, we are able to fit the entirety of price information into a cohesive pattern. This means that the price action from the 1929 top, and 1933 bottom has an effect on the current 2024 price action. The below chart is the entirety of the Dow Jones Industrial Average’s price information, which is organized into an on-going Elliott Wave pattern.

The reason that I am providing this chart today is because I want our readers to understand the larger backdrop of the current market. Within this context, the 1929 top to the 1933 bottom, was a very large degree 2nd wave. What followed has been a 3rd wave within the same large degree time frame. When you analyze the internal wave structure, it appears that we are coming to the end of this large degree 3rd wave, which is suggesting the start of a secular bear market. This secular bear market would constitute the large degree 4th wave. 

Furthermore, what this pattern is telling us is that the secular bull market that started in 2009 has actually been the 5th wave of this very large degree 3rd wave pattern. The below chart outlines this 5th wave, and organizes it into a its own 5 wave pattern.

We can further dissect this analysis and focus our attention deeper. According to the wave pattern above, the COVID low started the final 5 wave pattern within the larger 5 wave pattern above. As stated prior, these patterns are fractal, which allows us to organize each move into a cohesive pattern.

The below chart focuses on the smaller 5 wave pattern that started at the COVID low. With the above information in mind, we are able to have the proper context when trying to understand the current market. As of now, I have 2 potential scenarios on how to understand the final push in the secular bull market that started in 2009. 

Blue – This count has the 2022 bear market as a 4th wave within a larger uptrend. What this means is that the 2023 bull market is the final 5th wave, which is taking the shape of an ending diagonal (I discussed this pattern in last month’s report here). This is an overlapping 5 wave pattern that is characterized by large swings in both directions. It is very common to show up as a 5th wave. Considering that the pattern is almost complete, if not already, the risk within this market is greater than many believe.

Red – This count is based on the secular bull market ending on January 2022. What this means is that 2022 was the A wave of this new secular bear market, while 2023 was the B wave bounce. In other words, 2023 to now is a cyclical bull market within a secular bear market. If accurate, the next larger drop will take the shape of a vertical 5 wave pattern pointing down. This 5 wave pattern would retrace the entirety of cyclical bull market that started in October of 2022.

If we zoom in on the ending diagonal pattern that started in October 2022, we can get an idea of how much farther this market can stretch. We are currently in the toping zone between 5145 – 5345. As long as we hold 5090 SPX, we can keep pushing higher. Below 5090 will be the first warning to the bulls. A break below 5050 and then 4945 SPX will confirm that a larger top is in.

Once a top is in place, we can then get a better idea of whether the red or blue count is in play. The red count will be a large degree C wave, which always takes the shape of a 5 wave pattern. It would be a more direct path to our final downside targets. The blue count would be less of a direct path, which would have large bounces followed by breakdowns to new lows. It would be messier, and characterized by a multi-month rangebound market.

In concussion, if we are entering a secular bear market, this does not mean we should leave the markets. It simply means that we will have a period line 2000 – 2013 where the market goes sideways. These sideways periods have bear markets that are punctuated with multi-year bull markets. It is a period where buy and hold tends to struggle, and where a more active approach with a risk management focus could potentially navigate it profitably. 

Positions Report of Nvidia, Bitcoin, and Microsoft

Nvidia (NVDA)

Nvidia has either topped, or will see one more swing to, at least, the $1025 level. Price is in a wedge pattern and how it breaks will likely be the deciding factor. If we do break lower, the odds will favor a top. However, as long as it holds above $785, and then breaks above $915, we could see a new pattern develop that can take us higher in an extended 5th wave. Below $785 and the top is in for NVDA.

Bitcoin (BTCUSD)

There is no reason to doubt the above uptrend pattern in play as long as critical support holds on any weakness. The higher Bitcoin goes, the higher this critical support is raised. Today, the level that must hold in $42,500.

We are do for a pullback, which would be wave 4 of 3. These targets are around $57,000 – $48,000. Remember, $57,000 was strong resistance, and it is now strong support. If we get back to this price, we will likely add. However, we are in a 3rd wave; one we have accumulated for going back to late last year. Third waves tend to be marked with shallow pullbacks that leave investors behind. So, if we continue to see a push over $70,000, the odds will start shifting that the low is in for this drop. 

Microsoft (MSFT)

MSFT broke the February 13th high for a day, before falling back. The push higher appears to be a 5 wave pattern. It’s hard to believe, but this 5 wave pattern is wave 5 of 5 of 5 of 5 of 5, going all the way back to 2009. Below $397 and the top is in.

Advanced Market Signals Members receive in-depth technical analysis from our Portfolio Manager, Knox Ridley.  Learn more here.here.

Resources:

• Positions Update: Microsoft, Nvidia, and Bitcoin
• Nvidia Fiscal Q4: Yet Another Big Beat and Raise
• Nvidia Earnings Preview: 239% is the Revenue Growth Peak (for now)
• Positions Update: Microsoft, Nvidia, and Bitcoin
• Positions Report – February 2024

For reference to terminology used, please look at technical analysis under our resources section here. Regarding the horizontal lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.here. Regarding the horizontal lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.

Elliott Wave counts are meant to provide context. Each colored count represents the most probable paths given the current price data. There is a pattern unfolding in real-time, one of which will play out. By monitoring price levels that are held/broken, it will help us figure out which one is in play, so that we can better manage risk.

 

Broad Market Technical Analysis

Price Analysis

When you funnel the global community of investor into a quantifiable arena, like the stock market, interesting and repeatable patterns emerge. These patterns are the basis of technical analysis, and are used by analysts to predict market trends and establish risk parameters. The discipline of Elliott Wave analysis is simply an in depth study of these repeatable patterns, which provides the best context to market behavior that I know of.

For those new to this analysis, I have written up a detailed introduction here. The fundamental idea is that markets move up in a 5 wave pattern, and once this 5 waves pattern completes, we then see a 3 wave retrace/correction, which will make a higher low. This simple movement is not only happening on all time frames, and in all markets where people interact to find price discovery, but it is fractal. So, a small 5 wave pattern develops into a larger one, which then develops into a larger one, and so on. 

Because of the fractal nature within market patterns, we are able to fit the entirety of price information into a cohesive pattern. This means that the price action from the 1929 top, and 1933 bottom has an effect on the current 2024 price action. The below chart is the entirety of the Dow Jones Industrial Average’s price information, which is organized into an on-going Elliott Wave pattern.

The reason that I am providing this chart today is because I want our readers to understand the larger backdrop of the current market. Within this context, the 1929 top to the 1933 bottom, was a very large degree 2nd wave. What followed has been a 3rd wave within the same large degree time frame. When you analyze the internal wave structure, it appears that we are coming to the end of this large degree 3rd wave, which is suggesting the start of a secular bear market. This secular bear market would constitute the large degree 4th wave.

Furthermore, what this pattern is telling us is that the secular bull market that started in 2009 has actually been the 5th wave of this very large degree 3rd wave pattern. The below chart outlines this 5th wave, and organizes it into a its own 5 wave pattern.

We can further dissect this analysis and focus our attention deeper. According to the wave pattern above, the COVID low started the final 5 wave pattern within the larger 5 wave pattern above. As stated prior, these patterns are fractal, which allows us to organize each move into a cohesive pattern.

The below chart focuses on the smaller 5 wave pattern that started at the COVID low. With the above information in mind, we are able to have the proper context when trying to understand the current market. As of now, I have 2 potential scenarios on how to understand the final push in the secular bull market that started in 2009.

Blue – This count has the 2022 bear market as a 4th wave within a larger uptrend. What this means is that the 2023 bull market is the final 5th wave, which is taking the shape of an ending diagonal (I discussed this pattern in last month’s report here). This is an overlapping 5 wave pattern that is characterized by large swings in both directions. It is very common to show up as a 5th wave. Considering that the pattern is almost complete, if not already, the risk within this market is greater than many believe.

Red – This count is based on the secular bull market ending on January 2022. What this means is that 2022 was the A wave of this new secular bear market, while 2023 was the B wave bounce. In other words, 2023 to now is a cyclical bull market within a secular bear market. If accurate, the next larger drop will take the shape of a vertical 5 wave pattern pointing down. This 5 wave pattern would retrace the entirety of cyclical bull market that started in October of 2022.

If we zoom in on the ending diagonal pattern that started in October 2022, we can get an idea of how much farther this market can stretch. We are currently in the toping zone between 5145 – 5345. As long as we hold 5090 SPX, we can keep pushing higher. Below 5090 will be the first warning to the bulls. A break below 5050 and then 4945 SPX will confirm that a larger top is in.

Once a top is in place, we can then get a better idea of whether the red or blue count is in play. The red count will be a large degree C wave, which always takes the shape of a 5 wave pattern. It would be a more direct path to our final downside targets. The blue count would be less of a direct path, which would have large bounces followed by breakdowns to new lows. It would be messier, and characterized by a multi-month rangebound market.

In conclusion, if we are entering a secular bear market, this does not mean we should leave the markets. It simply means that we will have a period line 2000 – 2013 where the market goes sideways. These sideways periods have bear markets that are punctuated with multi-year bull markets. It is a period where buy and hold tends to struggle, and where a more active approach with a risk management focus could potentially navigate it profitably.

Supporting Markets

No one doubts that tech has been leading this uptrend higher. Since bottoming on October 13th 2022, the S&P 500 is up just over 40%. During the same time frame, small caps are up only 20%, while the tech heavy NASDAQ-100 is up over 70%, and The PHLX Semiconductor Index is up over 115%.

The consensus belief is that tech is leading the weaker markets, like small caps, higher. If true, then buying these weak markets appears to be a winning strategy, as they have a long way to go in order to final catch up with the market leaders.

However, when we view these markets through the lens of technical analysis, I believe that the stronger markets, like tech, are the ones playing catch-up, while the weaker ones, like small caps, are leading the larger trend. That being said, there are two types of markets – the ones that have topped, and the ones that are close to topping.

Small Caps

The Russell 2000 (IWM) is the most obvious pattern to track. From the 2009 low, we have a very clean 5 wave pattern into the 2021 top. Note how small caps have been trending sideways since the 2022 low, and they are substantially below their 2021 top. This looks like a large degree correction that has one more large leg pointing down before completing. 

When we zoom into this sideways pattern, it appears to be tracing a B wave bounce within a larger decline.  The key is the final move of the larger (B) wave being a 5 wave push higher. Note how we have a clear 5 wave pattern that tagged our $210 target (below). 

Further, the 5th wave is taking the shape of a clear ending diagonal pattern on decelerating momentum. If the next larger drop is a direct 5 wave move, then we have confirmation that we are setting up for a push below the 2022 lows.

There are several markets that resemble the small cap index above. In other words, they have been trending up from the 2022 lows in an overlapping pattern that resembles a bounce within a larger correction. The key is that these markets have trended sideways to up and are well below their 2021/2022 highs. Here are a few examples:

Consumer Discretionary (XLY)

Retail Sales (XRT)

Financials (XLF)

The 2nd type of market is the one that is still in their secular bull market. In other words, while the above markets ended their bull market in 2021/2022, the bellow leaders are completing their final 5th wave of the secular bull market. 

Technology (XLK)

The tech sector has the 2022 bear market as a 4th wave drop within a larger uptrend. This larger uptrend is coming to an end soon. Note now clear the 5 wave pattern is off the 2022 low. This 5 wave pattern is mature and full, as we push slightly higher on less momentum.

Industrials (XLI)

Interestingly, Industrials appears to be completing a large 3 wave push to new highs. This appears to be within the context of a large degree ending diagonal pattern.

Home Builders (XHB)

This market looks a lot like the S&P 500. It is completing an ending diagonal pattern for wave 5. Once complete, this should end the secular bull market for home builders.

In conclusion, from a basic understanding of technical analysis, one can see tech leading, with industrials and home builders breaking out to all-time highs and conclude that the weak markets will follow. This is simply not the type of market behavior we see going into a recession. Further, we are in a roaring bull market that seems to have no end, so it’s no wonder we see investors touting these weaker markets, like small caps, as the ones that will start playing catch-up.

However, within the context of Elliott Wave, these breakouts to new highs appear to be in the form of 5th waves, which are close to ending. What this means is that the weaker markets topped first in 2021/2022, while the stronger markets are the ones playing catch-up. This is also why there is such a bifurcation amongst analysts trying to put a cohesive narrative to this strange market behavior.

Divergences

When markets are moving in unison, you have a strong trend. However, when markets start diverging, we tend to see this behavior at the end of the trend. This is what is happening now. 

There is no question that big tech has been the market leaders throughout the entirety of this bull market that started in 2022. This is evident by the name given to these leaders – the “Magnificent 7.” However, what we are now seeing is that these market leaders, which were once moving in unison, are now starting to fall like dominoes.

First, Tesla topped in July of 2023, followed by Apple in December of 2023. We then saw Google top in late January of this year, followed by Microsoft in mid-February. What was once the Magnificent 7 is now the Magnificent 3, as the majority of past market leaders are now in a notable downtrends.

One could easily claim that we don’t need these stocks to move higher, obviously. However, when prior market leaders start to fall, more times than not, they are signaling exhaustion in the broader trend. What makes this instance so notable is the extreme weightings that these 4 stocks take up in the S&P 500. Together, they account for ~17% of index weighting. This is a large weight around the broad market, which should not be ignored.

Regional Banks are also diverging with the larger banks. These markets historically move together, and when they start separating, something isn’t right. Regional banks have made a series of lower highs while the bigger banks have gone to test all-time highs. One of these markets is leading, and until regional banks start making new highs, I do not trust this move higher with the big banks. 

The transportation sector is also signal a similar warning. The Dow Jones Transportation index is comprised of standard transportation stocks, while the iShares index has the same stocks, except with a higher weighting in the tech focused transportation stocks, like UBER and LYFT. Like the banks above, these two markets tend to move in unison. This is not the case today, as we see a sizable divergence that is not healthy.

The most notable divergence is between long-dated bonds (TLT) and the equities. Bonds tend to top/bottom long before equities get the message. Today, TLT is making a series of lower highs, while equities continue to power higher. The bond market is simply not buying this move higher, which is typically a harbinger for equity volatility.

Time Analysis

Elliott Wave analysis can tell you when a trend is coming to an end. It can also provide levels that must hold or break in order to confirm a pattern will extend or a counter pattern is emerging. Gann analysis provides you with time analysis. Markets move in cycles, and these cycles tend to create inflection points. More times than not, these inflection points mark trend reversals, and on occasions they mark large breakout/breakdown moves. I went through the Elliott Wave analysis for some key markets above, this section will look at the time analysis. Together, they are signaling caution.

Russell 2000 (IWM)

We discussed the concerning price analysis above. This market appears to have reached our target in a fully developed 5 wave pattern. This 5 wave pattern, I believe, is the final swing in a large corrective bounce that started in 2022 and is part of a larger bear market.

When we add the time analysis, we can see another layer of risk. The below chart tracks 3 cycles that have an effect on the price of IWM. Note how price tends to reverse its trend when it moves into one of these cycles. The most important piece of information regarding this cycle analysis is how price is moving into them. As of now, IWM’s price is moving up into all 3 of these cycles clustering right now.

Furthermore, when we place a Gann Fan at the 2018 low, note how the following price patterns reacted to these angles. Today, price is hitting against the most important angle in red. This is the 45 degree angle, and we tend to see strong reversals at this angle.

So, we have a significant confluence of price and time, which in Gann’s world tends to mark a meaningful trend reversal. When we factor this information in with the Elliott Wave analysis showing that we are in an ending diagonal pattern in the final 5th wave, it warrants caution.

Dow Jones Industrial Average (DJI)

I’ve discussed the Dow’s price pattern in several prior reports. No matter how you count this, the uptrend pattern off the 2022 low is setting up for a large pullback. The below chart shows various long-term cycles that have had an effect on DJI’s price movements. Note how we are seeing a cluster of these cycles show up now. When cycles cluster, it tends to mark a meaningful inflection point. For example, the last time these cycles clustered was around the 2020 top.

The NASDAQ-100

This index looks very similar to XLK above. It is completing a large degree 5 wave pattern off the 2022 low, and setting up for some type of trend reversal. Furthermore, it is trending up into a cluster of long-term cycles and hitting the 45 degree angle from the 2018 high. Much like other key markets, there is a confluence of price and time, which tends to mark trend reversals.

In conclusion, we are seeing several key markets trending up into a cluster of key cycles. Many of these markets are also hitting important angles from key inflection points in the past. These angles, along with the cycles tend to mark meaningful trend reversals. When we factor in price analysis, we can see that these same markets are in the final moves of very mature uptrend patterns. Price and time are coming together right now in a way that warrants caution until we see a resolution. If the market instead ignores these angles and cycles, it will be a show of strength that we will factor into our portfolio management. 

What If We Are Wrong?

I’ve laid out a strong position for an imminent market reversal. Both time and price seem to be suggesting this is the case amongst multiple key markets. However, all positions must have a point at which they are scraped and a pivot has to happen. Since our inception there have been a handful of pivots we have had to make, once a thesis appears to not be playing out. That being said, my alternative count is below. We would need to see SPX hold 4775 on the coming pullback, followed by a direct, 5 wave push to new highs.

Further, the divergences that I discussed prior would need to resolve. We would need to see all sectors in the S&P 500, along with the lagging FAANGs, resume their uptrend and make new highs. If this happens, you ‘ll will see us layer back into the market for the resumption of the larger bull market as we. Extend this bull cycle into 2025. I find this hard to believe, as most markets, like IWM, simply do not have an alternative interpretation that lines up with the above chart. However, we are prepared to pivot if this analysis is proven wrong. 

I/O Fund Portfolio

Because of the warnings stated above, the I/O Fund has taken a barbell approach to our portfolio in 2024. On one end, we are maintaining a defensive posture within our portfolio by holding a sizable cash position. On the other end, we are highly concentrated in market leaders such as NVDA, AMD, and Crypto. This strategy has worked out well for us this year, so far, as we continue to show relative outperformance while also being prepared for a sizable trend reversal.

Regarding our risk management, we have been very clear with the risks we see in this market. As a result, we have gone from being 85% net long in early November 2023 to 30% net long today. We are currently 35% hedged and waiting for our hedge signal to tell us when to go 100% hedged, and thus move toward being market neutral.

The below pie chart is the percentage allocation of our invested assets, not including cash.

Hedge Signal

The below is an update from Vincent Duchaine of WealthUmbrella, who created the hedge signal that we currently use.

Since the start of this year, market breadth has been considerably deteriorating. While some stocks continued their parabolic move higher, several stocks, including high beta stocks have declined considerably since their peak at the end of December 2023. Tesla is probably the most well-known example, being approximately down 35% from its July 2023 peak.

Market breadth is one of the primary components of the hedge signal. The on-going deceleration in market breadth has led to this component rising above the zero line for the third time since the beginning of this year.

This may seem insignificant, but just having a signal above 0 is something we typically do not see in strong uptrends. For example, during the bull market between June 2020 to December 2021, the signal stayed below 0 the entire run, and only rose above zero at the end of that bull market, just before the start of 2022.

Moreover, when the breadth component of the hedge signal rises above the zero line while the market continues to push higher, or even goes sideways, it has a high correlation with abrupt corrections. Though breadth is moving closer to a sell signal within the hedge, it is still in buy, for now. 

Another way we could see the hedge signal trigger a sell would be if the VIX rises drastically and enters full backwardation. Some components of the VIX ribbons are already in backwardation, so this scenario is a reasonable assumption to track.

 The other component of the signal that could trigger a sell is the options market. This component is less likely to trigger a sell, considering how the market has continued to defy gravity for so long now. This behavior is filtering into sentiment within the options flow.  I think the option market is as confused as everyone else, so it will likely not lead to a sell signal.

Regardless, one interesting aspect of the current state of options dynamics is in the SKEW. The SKEW printed a record high a few weeks ago. This is highly correlated with a more a pronounced drop in equities and something we are tracking closely.

Furthermore, with our proprietary market risk indicator comfortably in the red, we believe a more cautious stance in warranted.

Nvidia (NVDA)

Nvidia has either topped, or will see one more swing to, at least, the $1025 level. Price is in a wedge pattern and how it breaks will likely be the deciding factor. If we do break lower, the odds will favor a top. However, as long as it holds above $785, and then breaks above $915, we could see a new pattern develop that can take us higher in an extended 5th wave. Below $785 and the top is in for NVDA.

Advanced Micro Devices (AMD)

AMD appears to be at odds with NVDA and the rest of the market. The count below is what makes the most sense from the price action; however, it is suggesting a much larger uptrend is underway. I could see something like this happen as the broad market stays within a 5 – 12% range for the remainder of the year. As many stocks and markets make lower highs, AMD will go on to make higher highs, and thus complete the above pattern. I’m willing to hold onto this count as long as any weakness holds $159. Below this level and larger uptrend fails.

Another point of concern, AMD is now below $191. There was substantial institutional activity at this price level. For AMD to move higher, this level has to get reclaimed. We simply do not see block sales of this caliber and price continuing in a 3rd wave. So, as long as we stay below $191, we remain cautious.

Bitcoin (BTCUSD)

There is no reason to doubt the above uptrend pattern in play as long as critical support holds on any weakness. The higher Bitcoin goes, the higher this critical support is raised. Today, the level that must hold in $42,500. 

We are do for a pullback, which would be wave 4 of 3. These targets are around $57,000 – $48,000. Remember, $57,000 was strong resistance, and it is now strong support. If we get back to this price, we will likely add. However, we are in a 3rd wave; one we have accumulated for going back to late last year. Third waves tend to be marked with shallow pullbacks that leave investors behind. So, if we continue to see a push over $70,000, the odds will start shifting that the low is in for this drop.

Netflix (NFLX)

Note the bearish engulfing candle from last Friday. Netflix started the day green and then ended the day deep in the red. This happened on heavy volume, and it is what is called a key reversal candle. In other words, the type of candle that tends to happen close to a trend reversal. Netflix is completing the 5th wave of a larger 5th wave, so any additional upside should be limited from here. Below $544 and the top is in.

Ethereum (ETHUSD)

Ethereum is setting up for a bounce. Look at how deep the composite index went on this drop. This is typically where bounces occur. I’m expecting a b wave and final leg lower, but we may not get that if the next bounce is a 5 wave move higher. If this happens, it suggests the low is in for this drop.

Ethereum’s uptrend should continue higher as long as any weakness holds $2990. Below this level and my old red count will get reintroduced. As always, and especially within crypto, it’s best to not get married to a count and to be prepared to bail if a support region gets broken. As of now, this is not the case, so we will keep looking up. 

Super Micro (SMCI)

The 1st, 2nd and 3rd largest trade in SMCI’s history came within 72 hours of each other, and around the $1065 price level. We are significantly below this level, which implies institutional selling.  The next meaningful support levels are $865 and then $775. Below these levels and the odds build that the top is in. We have taken significant gains in this stock. In fact, we’ve sold about 12%, while only adding 6% at much lower levels. So, we have taken our cost basis off the table, plus ~100% gain. If we do see any further strength, we will continue to sell this position.

Crowdstrike (CRWD)

CRWD looks to have topped in a 3rd wave. The last push to new highs was in a 3 wave pattern, which looks like a B wave. This means the correction is an expanded flat, and the C wave should be quite sharp. I’m targeting around $265 for the 4th wave decline. If we break above the recent high, we can extend the 3rd wave, but eventually, and sooner rather than later, the 4th wave will have to happen.

Chainlink (LINKUSD)

Though it may appear that we are getting a 5 wave drop from the high, this drop appears to be part of an expanded flat correction. If so, this should be the A wave, followed by a 3 wave bounce for b and then another 5 wave drop pointing toward the $12 range.

Below is the count that makes the most sense from the price action. Note how we have 3 waves down, then 3 waves up to new highs. This is most likely the A and B of the expanded flat. If this plays out as expected, look for a 3-5% buy in our target zone.

Micron (MU) 

The move over $102 has forced me to rethink the potential counts in play. Since we are getting a gap over $102, then we should be heading to $154 in a larger 5th wave push. This breakout has to hold $102 or we could see a reversal. However, after that report, I find that to be unlikely.

Solana (SOLUSD)

Solana is in a 3rd wave. The 4th wave should take us back to the $137 – $85 range before turning back up for the 5th wave higher. If this drop from the high is a 5 wave move down, we will likely sell half of our gains on the bounce. Unfortunately, because we are dealing with such a large pattern, the critical support is below $85, for now. So, we will have to rely on the structure of the drop – 5 waves down will be an early warning sign. 

Cloudflare (NET)

I still hold to NET being in a very complex B wave. The final C wave of this B wave is a 5 wave push higher, and the final move in this corrective bounce. Either we topped with a break below $90, or we can hold $90 and see one more push towards $145.

Microsoft (MSFT)

MSFT broke the February 13th high for a day, before falling back. The push higher appears to be a 5 wave pattern. It’s hard to believe, but this 5 wave pattern is wave 5 of 5 of 5 of 5 of 5, going all the way back to 2009. Below $397 and the top is in. 

Resources:

• Q&A Webinar Replay – March 21, 2024
• Positions Report – February, 2024
• I/O Fund Crypto – Updated Technical Analysis
• Positions Report – January 2024

Micron delivered an exceptional fiscal Q2, with revenue rising nearly 58% as strong AI demand led to pricing power coupled with tight supply dynamics to accelerate its return to profitability this quarter. Q3 was guided 10% above consensus to $6.6 billion at midpoint, representing 76% YoY growth, pointing to an impressive rebound from declining growth just three quarters ago.

Margins were significantly ahead of expectations, driving a strong shift to profitability. Micron was initially expected to return to profitability next quarter, but reported a solid 13.6% GAAP net margin this quarter as operating margin expanded nearly 20 percentage points QoQ.

CEO Sanjay Mehrotra said Micron’s “preeminent product portfolio positions us well to deliver a strong fiscal second half of 2024,” as he believes the company “is one of the biggest beneficiaries in the semiconductor industry of the multi-year opportunity enabled by AI.”

There were many strong, bullish statements on the call: “AI server demand is driving rapid growth in HBM, DDR5 and data center SSDs, which is tightening leading-edge supply availability for DRAM and NAND. This is resulting in a positive ripple effect on pricing across all memory and storage end markets. We expect DRAM and NAND pricing levels to increase further throughout calendar year 2024 and expect record revenue and much improved profitability now in fiscal year 2025.”

For more information regarding the importance of HBM3 and HBM3e in Nvidia and AMD’s 2024 product road map for AI Accelerators, please reference our past analysis noted at the end of this analysis.

Revenue and EPS:

Revenue shows a clear and obvious rebound in the memory market and EPS was a blowout:

• Revenue of $5.82 billion beat estimates by ~9%, and represented YoY growth of 58% and QoQ growth of 23%.
• Fiscal Q3 revenue was guided at $6.6 billion, +/- $200 million, for YoY growth of 76% and QoQ growth of 13%.
• GAAP EPS was $0.71, compared to estimates for ($0.38). This compares to GAAP EPS of ($1.12) in Q1 and ($2.12) in the year ago quarter.
• Adjusted EPS was $0.42, compared to estimates for ($0.24). This compares to adjusted EPS of ($0.95) in Q1 and ($1.91) in the year ago quarter.
• GAAP EPS was guided at $0.17 +/- $0.07, compared to estimates for $0.08.
• Adjusted EPS was guided at $0.45 +/- $0.07, compared to estimates for $0.20.

Margins:

• GAAP gross margin was 18.5%, an expansion of 5120bp YoY from (-32.7%) and 1920bp QoQ from (0.70%). Management had guided for a gross margin of 12%.
• Adjusted gross margin was 20.0%. Gross margins “benefited from $382 million associated with selling the remainder of previously written-down inventories.”
• GAAP operating margin was 3.3%, an expansion of 6570bp YoY from (-62.4%) and 2720bp QoQ from (-23.90%). Management had guided for (-8.2%). Adjusted operating margin was 3.5%.
• GAAP net margin was 13.6%, an expansion of 7620bp YoY from (-62.5%) and 3970bp QoQ from (-26.1%). Adjusted net margin was 8.2%.

•  For Q3, GAAP gross margin was guided at 25.5% +/- 1.5%, an expansion of 700bp QoQ at midpoint. Adjusted gross margin was guided at 26.5% +/- 1.5%. Despite the rather large benefit in Q2 from selling written-down inventories, strong increases in DRAM and NAND pricing are driving this sequential expansion.
• For Q3, GAAP operating margin is implied to be 8.7% at midpoint, an expansion of 540bp QoQ. Adjusted operating margin is implied to be 11.5%, an expansion of 800bp QoQ. Micron is forecasting continued operating income through the rest of FY24.

Management made it crystal clear that HBM3 is accretive to margins. This has been a concern since it’s 3X more expensive to manufacture. The strength in the margin is due to pricing power.

“So with respect to the accretive nature of HBM, look, HBM carries a higher cost, but it also carries a significantly higher pricing because it brings such great value in the applications in terms of its performance and power. And we are executing well. Our yield ramp is going well as well according to plan.”

“And therefore, we are pleased that in this quarter, when we have begun our production shipments, we will be having it accretive to our gross margins in the quarter. And of course, this momentum will continue to build in the quarters ahead.”

“Answer
Mark Murphy (Executives)

Yes. Brian, it's Mark. We won't break it out specifically, but maybe just to give you a sense of the trajectory of gross margins. The increase from first quarter of 1% to 20% in the second quarter was dominantly price. And obviously, a lot of other things going on, but the dominant feature of that increase was price. 

Likewise, in the 20% second quarter actuals to the 26.5% guide, price remains the largest contributor. And offsetting part of that is, of course, what CJ mentioned on the benefit of those lower cost inventories fade away. So — but price is still the largest factor.”

Cash and Debt:

• Cash and short-term investments totaled $9.0 billion.
• Debt totaled $13.7 billion.
• Operating cash flow was $1.22 billion, an increase of 256% YoY but a decrease of (13% QoQ). The sequential decrease may have been impacted by strong pre-payments in the prior quarter from customers aiming to secure supply. Management commented last quarter there were $600 million in prepays but declined to comment on prepays this quarter.
• Adjusted free cash flow was ($29 million), compared to adjusted FCF of ($333 million) in Q1 and ($1.81 billion) in the year ago quarter. Micron is expecting to generate positive adjusted FCF in both Q3 and Q4.

Key Metrics:

• DRAM revenue was $4.2 billion, an increase of 21% QoQ. DRAM pricing increased by the high-teens QoQ. DRAM had increased 24% QoQ in the previous quarter, so this was the second quarter of strong DRAM growth which we covered here.
• NAND revenue was $1.6 billion, an increase of 27% QoQ. NAND pricing increased by more than 30% QoQ, offsetting a low single-digit QoQ decrease in bit shipments.
• Compute and Networking (CNBU) revenue was $2.19 billion, representing an increase of 26% QoQ and 59% YoY. Per mgmt comments: “Data center revenue grew robustly, and cloud more than doubled sequentially.”
• Mobile (MBU) revenue was $1.6 billion, representing an increase of 24% QoQ and 69% YoY. Per management comments: “an expected decline in volume was more than offset by improved pricing” and management confirmed mobile will recover this year: “Smartphone unit volumes in calendar 2024 remain on track to grow low to mid-single digits.”
• Embedded (EBU) revenue was $1.1 billion, representing an increase of 7% QoQ and 28% YoY.
• Storage (SBU) revenue was $905 million, representing an increase of 39% QoQ and 79% YoY. Per management comments: “Data center SSD revenue more than doubled from a year ago driven by share gains from Micron's products.”

Revenue Acceleration Strongly Underway

Fiscal Q2 reaffirmed that Micron’s revenue acceleration is strongly underway, as revenue and Q3’s guide came in well above expectations. Micron added that they are expecting to generate record revenue with “much improved” profitability in fiscal 2025. 

Fiscal Q3’s guidance would mark the highest quarterly revenue in seven quarters, coming in above $6 billion for the first time since the fourth quarter of fiscal 2022. This is driving the fastest acceleration that we have seen for Micron since late 2017.

Q3 is expected to see ~76% YoY revenue growth at midpoint, a 18 percentage point acceleration from Q2 and a 61 percentage point acceleration from when revenue inflected back to positive growth in Q1. However, it’s important to note that these YoY growth rates are viewed against extremely weak comps – the real test for the strength and scale of this acceleration will be fiscal 2025’s growth rates; for example, how close each quarter can stay to the 60% expected revenue growth in fiscal Q1 2025.

An improved pricing environment driven by AI server demand is aiding the revenue growth story. Micron said it was able to drive “robust price increases as the supply-demand balance tightened.”

In particular, AI server demand was seen “driving rapid growth in HBM, DDR5 (D5) and data center SSDs, which is tightening leading-edge supply availability for DRAM and NAND.” Micron said this is causing “a positive ripple effect on pricing across all memory and storage end market.” As a result, Micron is expecting prices to continue to increase through 2024 and into 2025.

Management expressed how unusual the demand for HBM3 is: “And 2024 volume as well as pricing is all locked up. 2025, as I mentioned, the volumes are largely allocated. A vast majority of our production supply is allocated, and some of the pricing is already firmed up. Keep in mind, this has never happened before, right, that we are talking about 2025, and we are sitting in CQ1, and we already have so much discussion around supply and pricing for 2025 getting locked up here as we speak.”

Tight Supply:

Once semiconductor segments are aligned in terms of a rebound, the impact from AI will be more evident. Inventory helps to foreshadow the strength of the rebound.

This is what management stated: “Inventories for memory and storage have improved significantly in the data center, and we continue to expect normalization in the first half of calendar 2024. In PC and smartphone, there were some strategic purchases in calendar Q4 in anticipation of a return to unit growth. Inventories remain near normal levels for auto, industrial and other markets.”

The words “tight supply” were repeated 7 times, which tends to translate to strong pricing power. Here are a few of the comments, which are important to note as the tone of the call was that this pricing power should only increase:

“We anticipate strong HBM demand due to AI, combined with increasing silicon intensity of the HBM road map, to contribute to tight supply conditions for DRAM across all end markets.”

“The trade ratio of 3:1, increasing demand in HBM, increased profitability of HBM is putting a non-HBM part of the memory in tight supply. This is why we say that leading-edge nodes are in very tight supply. And as a result, we would fully expect that D5 as well as other DDR products will improve in their profitability picture as well, given they're very much tight supply there.”

“And so, I mean, this overall tight supply environment bodes well for our ability to manage the pricing increases as well as keep an eye on demand-supply balance and remain extremely disciplined in driving the growth of our business in revenue and profits while continuing to execute our strategy of maintaining stable bit share.”

Note on HBM3e Progress

Micron’s HBM3e was a core part of our multi-faceted AI-driven growth thesis in December, and the company has provided positive updates on HBM3e development and revenue generation.

Management said “we commenced volume production and recognized our first revenue from HBM3E in fiscal Q2 and now have begun high-volume shipments of our HBM3E product.” The company is “on track to generate several hundred million dollars of revenue from HBM in fiscal 2024.”

Micron is expecting these HBM revenues “to be accretive to our DRAM and overall gross margins starting in the fiscal third quarter.” This is an important quote – Micron has already driven tremendous improvement in gross and operating margins in Q2, and this implies that HBM pricing power provided a tailwind to margins. Moving beyond fiscal Q3 and Q4 and into fiscal 2025, margins are expected to continue to expand at a fairly strong rate as HBM revenues ramp significantly.

Micron shed light on customers and capacity, noting that while its HBM3e will be a part of Nvidia’s H200 Tensor Core GPU, it is “making progress on additional platform qualifications with multiple customers.”

Micron’s upcoming 12-high HBM3e has been sampling to customers, and Micron said it will begin ramping the cube in high volume production throughout 2025: “Earlier this month, we sampled our 12-high HBM3E product, which provides 50% increased capacity of DRAM per cube to 36 gigabytes. This increase in capacity allows our customers to pack more memory per GPU, enabling more powerful AI training and inference solutions. We expect 12-high HBM3E will start ramping in high-volume production and increase in mix throughout 2025.”

Nvidia’s H200 win is major win for Micron, as competition in the HBM landscape remains stiff. Per management: “NVIDIA announced its next-generation Blackwell GPU architecture-based AI systems, which provides a 33% increase in HBM3E content, continuing a trend of steadily increasing HBM content per GPU. Micron's industry-leading high-bandwidth memory HBM3E solution provides more than 20x the memory bandwidth compared to standard D5-based DIMM-server module.”

Market leader SK Hynix, who had shipped HBM for Nvidia’s H100, is investing at least $1 billion this year to improve stacking and yields for HBM3/3e, while Nvidia just confirmed that it is qualifying Samsung’s HBM for next-gen GPUs.

While it is not certain that Samsung will pass the qualification stage, it raises questions whether this qualification is for the B200 or another upcoming GPU, or whether Nvidia is seeking to qualify HBM products from all three manufacturers in order to secure ample supply in 2025 and 2026 (given that Micron’s capacity is nearly booked and SK Hynix just commenced HBM3e mass production).

Per Micron, the following sets them apart: “Customers continue to give strong feedback that our HBM3E solution has a 30% lower power consumption compared to competitors' solutions. This benefit is contributing to strong demand.”

Though it is rumored that SK Hynix is shipping to Nvidia’s Blackwell lineup, Micron raises a critical point: the architecture “provides a 33% increase in HBM3E content, continuing a trend of steadily increasing HBM content per GPU.” This trend for higher memory content to support larger and faster GPUs is likely to continue especially as chipmakers such as AMD work quickly to encroach on Nvidia’s share with comparable or faster GPUs.

Additional Growth Opportunities

HBM3e is stealing the spotlight but it’s worth mentioning a few additional growth opportunities for Micron:

• The company is releasing a 128-gigabyte server DRAM module that will provide high bandwidth D5 capability and greater than 20% energy efficiency with 15% better latency compared to Samsung’s 3D TSV solutions. This product has “strong customer pull” with “several hundred million dollars of revenue in the second half of fiscal 2024.”
• Micron reported record revenue share in the data center SSD market last year. In the current quarter, MU grew revenue by 50% QoQ for the 232-layer based 6500 30 terabyte SSDs. These are used for AI data lake applications.
• Edge AI – PCs will be a growth market for Micron. As stated above, mgmt expects PCs to return to growth in CY2024 in the “low single-digit range.” The neural processing units (NPU) chipsets that AI PCs require will see 40% to 80% more DRAM content than non-AI PCs.
• Edge AI – AI phones will require 50% to 100% more DRAM content than non-AI phones.

Conclusion:

A company that is supplying Nvidia (and likely AMD, perhaps Broadcom) on critical memory components for GPUs this year, HBM3E, plus will afford us an early entry for Edge AI with spring-loaded margins and strong pricing power that is expected to increase? Yes, please.

I’m quite positive you will see a new buy alert on Micron tomorrow and we are also looking at entering Lam Research (see below for LRCX analysis).

The report tonight has many implications for a thesis we have been carefully building on a memory rebound, which with some careful risk management, should have a long runway with Edge AI up to bat next (2025).

A special thank you to my team of analysts – Damien, Royston and Knox — who have worked diligently to identify this thesis. Go team go.

Resources:

• 2024 Trend: Memory and PC Rebound
• Memory and PC Stocks Review
• Micron: AI Offers a Multifaceted Secular Growth Tailwind
• Micron Q1: The Memory Rebound has Arrived Fueled by HBM3e – notes on anticipated NVDA partnership
• Micron Q2 Pre-Earnings: Signs of Rebound
• Lam Research: Wafer Fab Equipment Leader & HBM/DRAM Memory
• AMD is Ready to Rival on AI Acceleration – notes on upcoming GPUs with HBM3 memory

Micron will release its results on March 20th. The company reported 15.7% revenue growth in the last quarter, breaking the string of five quarters of negative growth. Management expects revenue to grow 43.5% YoY to $5.3 billion.

Higher prices and better utilization rates are also expected to improve the company’s margin profile in 2024, along with contribution from higher margin high-bandwidth memory (HBM).

The company will be in focus as HBM3e emerges as a significant enabler of generative AI applications and a significant growth driver over the next few years. Micron has recently started volume production of HBM3e, and more details will likely be revealed during the earnings call.

Revenue

Micron reported 15.7% YoY growth to $4.73 billion in the recent quarter after five quarters of negative growth.

• DRAM revenue grew by 24% QoQ to $3.4 billion, primarily helped by increased bit-shipments in the low 20% and improved prices by a low single-digit percentage. DRAM revenue constituted 73% of total revenue.
• NAND revenue grew by 2% QoQ to $1.2 billion, primarily helped by 20% price growth.

Revenue guidance for the next quarter is $5.3 billion at the midpoint, representing YoY growth of 43.5%. The company’s CFO, Mark Murphy, said in the earnings call, “Now turning to our outlook for the fiscal second quarter. While we remain mindful of macroeconomic risks, the memory and storage market environment is improving. We expect supply-demand balance to tighten in both DRAM and NAND throughout 2024. Our leading-edge DRAM and NAND nodes are oversubscribed for the full year. Consequently, we expect prices to increase through calendar 2024, driving improvements in our financial performance.”Our leading-edge DRAM and NAND nodes are oversubscribed for the full year. Consequently, we expect prices to increase through calendar 2024, driving improvements in our financial performance.”

The analysts expect revenue to grow 44.6% YoY to $5.34 billion in the next quarter and accelerate to 59.5% in Q3 and 70.6% in Q4.

Margins

Margins have gone through a steep cyclical low and have been showing signs of improvement. The GAAP gross margin was (0.7%) in Q1, compared to 21.9% in the year ago quarter. It marked a 1010 bps QoQ improvement from (10.8%) in Q4. The decline in gross margin compared to the previous year was due to the lower average selling price for DRAM and NAND and $165 million of underutilization costs in Q1.

The sequential rise in gross margin was due to improved prices and higher DRAM revenue mix, and it benefitted from $600 million from the sale of inventory written down in the prior periods. Mgmt expects around $400 million from a similar inventory benefit in the next quarter. The management guide for the next quarter is 12% at the mid-point. The adjusted gross margin was 0.8% compared to 22.9% in the same period last year. The management guide for the next quarter is 13%, helped primarily due to the improvement in prices, lower utilization charges, and the benefit from the sale of inventory.

The operating margin was (23.9%) compared to (5.1%) in the same period last year. The management guide for the next quarter is (8.2%). The adjusted operating margin was (20.2%) compared to (1.6%) in the same period last year. The lower operating margin was due to the factors discussed in the earlier paragraphs, higher R&D expenses, and the reinstatement of certain compensation programs that were suspended in the prior fiscal year. Management expects operating expenses to be lower in the next quarter due to lower R&D expenses and an asset sale previously anticipated in Q1. The management guide for Q2 is (4.9%) and expects to return to positive adjusted operating income in the third quarter.

Due to the various factors discussed above, the company reported EPS of ($1.12) in the recent quarter compared to ($0.18) in the same period last year. The adjusted EPS came at ($0.95) compared to ($0.04) in the same period last year.

The management guide for the GAAP EPS is ($0.45) at the mid-point for Q2 and adjusted EPS of ($0.28) at the mid-point. The analysts expect adjusted EPS of ($0.26) in the next quarter and a return of profitability in Q3 with adjusted EPS of $0.19.

Cash Flow and Balance Sheet

The operating cash flow grew by 48.6% YoY to $1.4 billion. The operating cash flow in Q1 benefitted from $600 million of customer prepayment “to secure supply for leading-edge memory products.” The operating cash flow margin was 29.6% compared to 23.1% in the same period last year. The adjusted free cash flow came in at negative ($333 million) and included capital expenditures of $1.7 billion compared to capital expenditures of $2.5 billion in the same period last year. The adjusted free cash flow margin was (7%) compared to (37.4%) in the same period last year. The company’s CFO said in the earnings call, “We see operating cash flows improving substantially in the second-half of the fiscal year and are now forecasting positive free cash flow in the fiscal fourth quarter.”positive free cash flow in the fiscal fourth quarter.”

The company had cash and investments of $9.8 billion and debt of $13.5 billion in Q1 compared to $10.5 billion and $13.3 billion in Q4. The short-term debt is $908 million and the weighted average maturity of the company’s debt is 2030.

Key Metrics from Business Units

Compute and Networking Business Unit (CNBU) revenue declined by (1%) YoY and is up 45% sequentially to $1.74 billion, as data center and client shipments strengthened in Q1 primarily helped by AI demand and normalized inventory at client customers. We want to see more recovery in compute and networking, as the segment was as high as $3.8B in Q4 of FY2021 and $3.9B in Q3 of FY2022.

The Mobile Business Unit shows signs of recovery, growing by 7% QoQ and by 97% YoY to $1.29 billion. The company’s CFO, Mark Murphy, said in the earnings call, “Mobile revenue continued to show strength as customer inventories normalized and smartphone units and average memory and storage capacity growth at customers drove demand.” We would also like see the recovery continue, as the mobile segment was at $1.89 billion in Q4 of FY2021 and $1.97 billion in Q3 of FY2022.

Embedded Business Unit (EBU) grew by 21% sequentially and by 4% YoY to $1.04 billion helped by growth in most of the end markets.

Storage Business Unit (SBU) revenue declined by (4%) YoY and (12%) sequentially to $653 million due to lower consumer component sales and partially offset by strong growth in SSD revenue.

Other noteworthy points to watch

• In the earnings call, CEO Sanjay Mehrotra talked about the AI tailwinds, “We expect 2024 to be a year of recovery and can see the path towards a healthy supply-demand environment along with strong growth in critical new technologies like HBM3E. From the data center to the edge, AI has emerged as a significant secular driver that will further bolster the industry towards record revenue TAM in 2025 and drive growth for years to come. Micron's broad and growing suite of leading-edge products positions us well to capitalize on the immense opportunities ahead.” strong growth in critical new technologies like HBM3E. From the data center to the edge, AI has emerged as a significant secular driver that will further bolster the industry towards record revenue TAM in 2025 and drive growth for years to come. Micron's broad and growing suite of leading-edge products positions us well to capitalize on the immense opportunities ahead.” Any key insights on the 2024 trends are to be watched.
• Management comments on HBM3E are to be closely watched in the upcoming earnings. The company’s CEO Sanjay Mehrotra said in the last earnings call. “Micron is addressing these exciting opportunities brought on by the proliferation of AI with an industry-leading portfolio of data center solutions, including HBM3E, D5, several types of high-capacity server memory modules, LPDRAM, and data center SSDs. We have received very positive customer feedback on our HBM3E, which has approximately 10% better performance and about 30% lower power consumption compared to competitive offerings of HBM3E.”We have received very positive customer feedback on our HBM3E, which has approximately 10% better performance and about 30% lower power consumption compared to competitive offerings of HBM3E.”
  
  In fiscal Q1, we shipped samples of HBM3E to a number of key partners and are making good progress in our qualifications. Micron is in the final stages of qualifying our industry-leading HBM3E to be used in NVIDIA's next-generation Grace Hopper GH200 and H200 platforms. In addition, our LP5x is being used for the Grace CPU, driving a new use case for LP memory in the data center for accelerated computing.
  
  We are on track to begin our HBM3E volume production ramp in early calendar 2024 and to generate several hundred millions of dollars of HBM revenue in fiscal 2024. We expect continued HBM revenue growth in 2025, and we continue to expect that our HBM market share will match our overall DRAM bit share some time in calendar 2025.”

  The company has confirmed recently that they have begun volume production of HBM3E. TD Cowen Analyst Krish Sankar pointed out that they expect Micron to increase its market share in the HBM market significantly to over 25% in the next year from the current 10-15%.

  Here is press coverage on Micron and Nvidia.

• Margin improvement and management comments on the margins are key items to watch in the earnings call. The company’s CFO answered the analyst’s question on gross margin improvement. “We are seeing some cost declines occurring with the increase of leading node production, and then again with the lower wafer starts and the higher utilization. What we've talked about before, we start to see idle charges dropping, as we've discussed. So again, principally price in the second quarter, but then beginning to see some cost benefits, even though we're losing the benefit of that lower cost inventory.We are seeing some cost declines occurring with the increase of leading node production, and then again with the lower wafer starts and the higher utilization. What we've talked about before, we start to see idle charges dropping, as we've discussed. So again, principally price in the second quarter, but then beginning to see some cost benefits, even though we're losing the benefit of that lower cost inventory.
  
  We will see price appreciation through the year. We're going to — we don't expect there to be volume growth in the third quarter either, but good price appreciation, which will drive gross margins up. And then in the fourth quarter, we would expect to see volume and price, and again some lower utilization charges. So again, we would expect to see margin expansion second quarter to third quarter, and then again third quarter to fourth quarter.”
  We will see price appreciation through the year. We're going to — we don't expect there to be volume growth in the third quarter either, but good price appreciation, which will drive gross margins up. And then in the fourth quarter, we would expect to see volume and price, and again some lower utilization charges. So again, we would expect to see margin expansion second quarter to third quarter, and then again third quarter to fourth quarter.”

Conclusion

The company’s Q1 FY2024 results showed that Micron’s recovery is underway. We would like to see this positive trend continue in Q2 with margin expansion in the coming quarters and a commitment to positive free cash flow by the end of the fiscal year 2024.

Recommended Reading:

• Arm-Based PCs and AI Edge Devices
• Broadcom: $10B in AI Revenue This Year Plus Software is Rapidly Accelerating
• Marvell Q4: Data Center Strong but AI Slow to Materialize
• Nvidia Fiscal Q4: Yet Another Big Beat and Raise

Edge AI will be an important trend with AI-powered PCs allowing more people to access the full benefit of AI-powered applications. This, in turn, will help AI developers build a bigger ecosystem. There is a bottleneck right now for AI applications to where client devices are not powerful enough or energy efficient enough to leverage AI capabilities. We’ve discussed this previously in our Memory and PC analysis with details on the upcoming Windows 12 upgrade, and also in the Memory and PC stocks write-up

Inference is also pushing forward the need for AI Edge devices and networks to be more powerful, but also more energy efficient. Inference takes batches of real-world data and quickly comes back with an answer or prediction. This is best done at the edge, which includes the edge network that a company like Cloudflare provides, and edge devices, such as smartphones and laptops. In the inference stage, the compute intensive neural networks are modified for speed and to improve latency. In order to do this, inference is optimized for runtime performance. This allows the computation tasks to be as close to the data source as possible. In many cases, data is produced at the edge, and it’s more efficient and faster to run inferencing at the edge. We’ve covered this in the past in our Cloudflare analysis.

Arm-based PCs are sparking competition, and this will be more evident this time next year (Q1 2025). The analysis below expands on the topic of Edge AI devices to discuss what 2024 will bring, and how we want to be positioned for 2025.

x86 versus Arm versus RISC-V

If Arm-based PCs stick this time, it will mark a massive shift in edge devices. X86 dominates PCs as it stands today, yet AI leaders have their roadmaps loaded with Arm-based releases over the next year. This will be Qualcomm in 2024, followed by Nvidia and AMD in 2025.

x86 and x64 Computer and Laptop Processors:

x86 is a set of design instructions and the architecture for nearly every desktop and laptop computer except MacBooks. The x86 architecture has been around for decades and is considered the standard in personal computers and servers due to its high clock speed and ability to execute multiple instructions per clock cycle. When it comes to performance, the x86 architecture is superior with additional features such as hyper-threading and turbo boost, which assists with tasks that require high computational power. In the early 2000s, x64 was built on top of x86 and is the dominant complex architecture. 

Arm-Based Architecture: 

A few years ago, MacBooks switched from Intel’s x86-64 processors to Apple’s system on a chip (SoC) based on Arm 64 architecture. Arm offers much lower power consumption and generates less heat due to being a Reduced Instruction Set. The M2 is built on Taiwan Semi’s 5nm process with 100GB/s memory bandwidth and 24 GB of unified memory. When the M2 was released in 2022, Apple claimed 1.9X CPU performance at the same power. At the same performance level, Apple claims the M2 uses ¼ the power as x86.

Source: Apple

The M3 MacBook Air is hitting stores this month with Apple stating it’s 13X faster than an x86 Intel powered MacBook. The Arm-based system on a chip (SoC) combines a CPU and a GPU with a 16-core Neural Engine for what Apple is calling the “World’s Best Consumer Laptop for AI.”

To understand why Apple chose to go with Arm-based architecture and why Microsoft Windows has to play catch up in 2024, it’s important to understand what Arm offers.

The name Arm stands for “Acorn RISC Machine” with RISC standing for reduced instruction set computer. Reduced instruction set leads to lower power consumption and less heat. Decades ago, in the early 1980s, founders Sophie Wilson and Steve Furber discovered that a CPU can run faster on a small set of instructions. This means the operating system breaks down tasks rather than add more instructions to the processor. While most CPU designs were adding more instructions to chips, Arm patented the technique of using fewer instructions that run more quickly and efficiently.

CPUs require instruction sets that tell the processor to move data between registers and memory or to perform calculations with a specific execution unit. Architecture is defined by providing the link between instructions and processor hardware designs. Here’s what Arm’s instruction set looks like.

However, a major difference is that Intel maintains its IP in-house and sells chips while Arm licenses its IP. Revenue is generated from licenses for Arm’s technology and royalties that come from the sale of a licensees’ chips that contain Arm’s technology.

Arm Dominates Mobile, and AI May be the Catalyst for Arm to Dominate PCs:

Around 2012, mobile phones began using the 64-bit architecture that PCs had been using for some time. Arm introduced the ARMv8 64-bit architecture for mobile in 2011. This architecture has two execution states to run 32-bit code and 64-bit code. To run on both Arm and Intel architectures, a developer might compile native code for both or run code emulation, although it is more common to choose one and stick with that choice. This is why we see near ubiquity with Arm on mobile whereas Intel and AMD have done quite well in the data center. Due to power constraints of the mobile device, which was introduced much later, Arm found a massive market where it dominates at 99% market share of smartphones.

Today, Arm offers the most popular CPU architecture in the world with 250 billion chips shipped since inception, of which 30.6 billion were shipped in FY2023. As stated, Arm is most dominant in mobile CPUs with 99% market share, and is at 40.8% in automotive. The overall share of Arm’s related markets is 48%. The company’s dominant market share is achieved through its developer ecosystem.

For mobile, Arm’s design known as “heterogenous compute” has helped facilitate lower power requirements as the architecture allows different CPU parts to work together for improved efficiency. This enables workloads to work across both high-performance and low-performance CPU cores to lower energy by balancing performance.

Arm’s architecture is the best choice for mobile and Intel’s x86-64 is the best choice for the data center and PCs. However, we are on the precipice of going through a major shift to where Arm architecture will compete with x86 architecture for PCs. This has been promised many times in the past, yet starting with Qualcomm’s Snapdragon Elite X, there is a chance that a viable Arm-based Windows PC finally happens. To improve the chances an Arm-based PC finally sticks, both AMD and Nvidia are preparing to release Arm-based PC systems in 2025.

Arm’s different licensing models are the following:

Arm Total Access Agreements: It is a type of licensing model wherein the company provides a package of CPU designs and related technologies for an annual fee. The agreement has a fixed term and Arm reserves the right to modify the package by adding or removing specific products. 

Arm Flexible Access Agreements: This model provides a selection of CPU designs and related technologies for an annual fee. However, the latest products are not included. In comparison, the total access agreement is a comprehensive package. Another key difference is that the customers need to pay a single-use license fee for specific products if they are included in the final chip design. Like total access agreements, the company reserves the right to modify the package.

Technology Licensing Agreements: It involves licensing a specific CPU design or technology to the customer for a fixed fee. The license can be used for a fixed term or the number of uses.

Architecture License Agreements: Under this agreement the customers design their own customized CPU designs using the Arm’s Instruction Set Architecture (ISA).

RISC-V

For the fiscal year ending March 2023, more than 260 companies have reported shipping Arm-based chips, including Amazon, Alphabet, AMD, Nvidia, Qualcomm, and Samsung.

Arm is based on lower power instruction sets and hardware, which is also known as a RISC architecture or Reduced Instruction Set Computing. As stated, this contributes to Arm’s approach to power efficiency by reducing the number of instruction sets required. Intel and AMD’s x86 CISC, or Complex Instruction Set Computing, offers more complex instructions that execute multiple operations. This leads to better performance but more power consumption due to the need to decode the complex instructions.

There is a third competitor to Arm and x86 which belongs in the RISC architecture category, called RISC-V. The instruction sets for RISC-V are similar to Arm’s yet RISC-V is open source and is also very new with an official launch in 2019. Compare this to Arm, which was founded forty years ago. RISC-V emphasizes register access over direct memory access, which may be more suitable for parallel processing.

It’s unlikely that RISC-V overtakes Arm in the near-term but it could become a serious contender in future years. Companies like SiFive and Imagination Technologies are designing RISC-V processors. Think Silicon released a RISC-V GPU in 2022. As of last year, AMD’s Radeon RX 6700 works with the RISC-V platform from SiFive.

According to Ars Technica, Qualcomm is also starting a joint venture with NXP, Nordic, Bosch and Infineon “aimed at advancing the adoption of RISC-V” with a focus on automotive use cases. With that said, there are not many games that support RISC-V and it has a long way to go to become a true competitor to Arm.

Arm Holdings Financials:

Arm Holdings is positioned to capitalize on the growing adoption of artificial intelligence (AI) technologies, leveraging its established licensing model and extensive ecosystem to drive future growth. Arm's established licensing model offers a recurring and relatively stable income source.

However, despite Arm dominating the smartphone market at 99%, the company has made very little on licensing compared to its partners. For example, mobile handsets created a $200+ billion segment for Apple, which relies on Arm technology for the iPhone, yet only resulted in (roughly) $3 billion for Arm. In this case, it was far better to own Apple.

The market is excited about the fact that AI will drive double the licensing fees for Arm. My contention is that, similar to mobile, it’s better to own the AI leaders who license Arm’s technology rather than Arm. Analyst estimates have Arm growing to $6.5 billion by 2028. For our purposes, this isn’t high enough growth to ensure insiders won’t take their exit following the IPO lock-up expiration – and frankly, the valuation on Arm is absurd at 41.9 Forward PS and 108 Forward PE Ratio. There is no riskier proposition than an IPO that is richly valued.

In the event the valuation comes down drastically (which it likely will, given IPOs tend to selloff sharply in the year following lockup expiration), we’ve done a thorough analysis on Arm as it’s a central player to Edge AI and is key to the next phase for AI.

Armv9 Architecture

The latest Armv9 architecture offers significant improvements in performance and efficiency, particularly for artificial intelligence (AI) applications. This has led to increased adoption by its partners, particularly in the premium smartphone segment.

Compared to the previous Armv8 architecture, Armv9 chips command double the royalty rate. This means Arm receives a higher percentage of the chip's selling price when a manufacturer uses Armv9 designs.

The rapid growth in Armv9 adoption and its higher royalty rates have already contributed to a significant increase in Arm's royalty revenue. Armv9 constituted 10% of royalty revenue in the September quarter and accelerated to 15% in the recent quarter. By doing the math, Armv9 revenue grew 69% QoQ to $70.5 million. As adoption continues to rise, the Armv9 architecture is expected to be a major driver of future royalty income growth for Arm.

Addressable Market

The company’s total addressable market was $203 billion in 2022 and is expected to grow at a compound annual growth rate (CAGR) of 6.8% to $247 billion in CY2025. The company has maintained a market share of over 99% in the mobile applications processor market. It expects this market to grow at a CAGR of 6.4%, from $29.9 billion in 2022 to about $36 billion in 2025. The company estimates that the aggregate value of chips that contain Arm technology was $98.9 billion (48.9% market share) for the CY ending December 2022, up from 38.7% in 2014. Notably, the 6.8% CAGR is a low CAGR for an AI trend with AI chips expected to grow at a 38.2% CAGR.

Arm also has strong market share of 40.8% in the automotive chip market. Management expects the automotive chip market to grow from $18.8 billion in 2022 to $29.1 billion in 2025, growing at a CAGR of 15.7%.

The cloud compute chip market is expected to grow at a CAGR of 16.6% from $17.9 billion in CY2022 to $28.4 billion in CY2025. Arm’s market share in the cloud computing chip market has increased from 7.2% in CY2020 to 10.1% in CY2022. Since Arm-based chips are increasingly used in data centers, its market share is expected to increase significantly in the future. Per the prospectus, “Arm-based chips have been gaining market share as CSPs, such as Amazon AWS and Alibaba, have started to deploy Arm products in their own in-house designed chips used in their data centers, and as other CSPs, such as Microsoft and Oracle, start to deploy chips designed by Arm licensees, such as Ampere. As a result, we expect our market share of cloud compute to grow significantly faster than the overall cloud compute market.”

Financials

Arm’s recent Q3 FY2024 revenue ending December grew by 13.8% YoY to $824 million, helped by the recovery in the smartphone market and demand for AI technology. This marks the second consecutive quarter of positive revenue growth, following declines of (2.5%) in the June quarter and (3.7%) in the March quarter, due to the cyclical downturn from smartphones.

License and other revenue grew 18% YoY to $354 million. The company has seen strong growth in license revenue as they are signing long-term and high value agreements with its customers due to demand for Arm’s advanced CPUs to run AI workloads. The trend was strongest in the Sept quarter as license revenue grew by 106%.

The company’s CEO, Rene Haas, said in the earnings call, “And that has seen growth in not only the smartphone sector but also in infrastructure and other markets, which drives growth. We are also seeing strong momentum and tailwinds from all things AI. From the most complex devices on the planet for training and inference, the NVIDIA Grace Hopper 200 to edge devices such as the Gemini Nano Pixel 6 from Google or the Samsung Galaxy S24, more and more AI is running on more end devices, and that's all running on Arm.”strong momentum and tailwinds from all things AI. From the most complex devices on the planet for training and inference, the NVIDIA Grace Hopper 200 to edge devices such as the Gemini Nano Pixel 6 from Google or the Samsung Galaxy S24, more and more AI is running on more end devices, and that's all running on Arm.”

They expect another record quarter for the licensing revenue. The company’s CFO, Jason Child said in the earnings call. “We are expecting another strong quarter for licensing with revenue up sequentially to near record levels. As with recent quarters, we expect to sign multiple new ATA deals in Q4, and demand for our latest technology remains high as customers need access to AI-capable CPUs and related technology such as our Compute Subsystems.”we expect to sign multiple new ATA deals in Q4, and demand for our latest technology remains high as customers need access to AI-capable CPUs and related technology such as our Compute Subsystems.”

The company also reported record royalty revenue due to its higher value Armv9 technology and also market share gains in cloud server and automotive markets. Royalty revenue rebounded to 11% YoY growth to $470 million from a decline of (5%) and (8%) in the previous two quarters. Management’s guide for the next quarter is to grow over 30% YoY and mid-single digits sequentially.

The company’s CFO, Jason Child said in the earnings call, “Within Q4 total revenue, we expect royalty revenues to grow mid-single digits sequentially and to be up over 30% year-over-year as we compare against the bottom of the industry wide inventory correction that occurred in prior year Q4. Royalty revenue sequential growth is mainly coming from increasing penetration of Armv9, where royalty rates are on average, at least double the rates on equivalent Armv8 products. Additionally, we are seeing an increasing amount of Arm technology in chips being deployed and as the amount of Arm technology in chips increases, so does the royalty rate.”increasing penetration of Armv9, where royalty rates are on average, at least double the rates on equivalent Armv8 products. Additionally, we are seeing an increasing amount of Arm technology in chips being deployed and as the amount of Arm technology in chips increases, so does the royalty rate.”

The management has increased its revenue guidance for the next quarter by $95 million to a range of $850 million to $900 million, representing YoY growth of 38.2% at the midpoint. The strong upward revision was due to the points discussed earlier, like the rebound in royalty revenue and the higher revenue opportunity from AI.

Analysts expect revenue to grow 37.4% YoY to $869.88 million in the next quarter and 27.9% in the June quarter.

FY2023 revenue ending March declined by (0.9%) YoY to $2.679 billion. Analysts expect FY2024 revenue to grow 18.7% YoY to $3.18 billion and 23.9% YoY to $3.94 billion for FY2025. 

Annualized Contract Value

Annualized Contract Value (ACV) grew by 15% YoY and by 5% QoQ to $1.16 billion. The sequential increase was due to an increase in high-value license agreements and also the increase of total access agreements.

RPO

Remaining performance obligations (RPO) grew by 38% YoY to $2.43 billion, helped primarily by high-value license agreements and renewal of long-term customer agreement. As per the shareholder letter, “We expect to recognize approximately 28% of RPO as revenue over the next 12 months, 26% over the subsequent 13-to-24-month period, and the remainder thereafter.”

Margins

Gross margin was 95.6% in the recent quarter compared to 96% in the same quarter last year. Adjusted gross margin improved 50 basis points YoY to 96.8%.

Operating margin was 16.3% compared to 33.7% in the same period last year. The operating margin was lower due to the increase of R&D expenses from an increase in engineering headcount and SG&A expenses from increase of non-engineering headcount.

In the Sept quarter, the operating margin was low at (19.4%) due to increased R&D expenses, stock-based compensation, and IPO-related expenses. Stock-based compensation was higher than it’s expected to be in future quarters as the IPO triggered a one-time expense for previously granted shares. As per the September quarter shareholder letter, “Total share-based compensation cost (equity-settled) was $509 million with $19 million in cost of sales, $343 million in R&D and $147 million in SG&A. Share-based compensation costs were higher in Q2 than is expected in future quarters as the IPO triggered a one-time expense for previously granted shares. The future run-rate of share based compensation cost will depend on a number of factors, including the share price, but is currently expected to be between $150 million to $200 million per quarter.” At the midpoint, this will be about 20% of revenue.

Adjusted operating margin was 43.8% compared to 39.9% in the same period last year and 47.6% in the Sept quarter.

Net margin was 10.6% compared to 25.1% in the same period last year and (13.7%) in the Sept quarter. The adjusted net margin was 39.3% compared to 31.1% in the same period last year and 46.9% in the Sept quarter.

Cash Flow and Balance Sheet

The operating cash flow margin was 37.6% compared to 56.8% in the same period last year and 28.2% in the Sept quarter. The free cash flow margin was 30.5% compared to 53.5% in the same period last year and 21% in the Sept quarter.

The company has cash and short-term investments of $2.4 billion compared to $2.2 billion in the Sept quarter, and no debt.

Key Metrics

The company reports the actual chips shipped in the subsequent quarter. For the quarter that ended September, Arm’s customers shipped 7.7 billion chips, down (3%) YoY and up 8% QoQ, showing a sequential improvement for the second consecutive quarter on account of smartphone market recovery and demand for AI chips.

Total Access Licenses

Total Access Licenses grew by 80% YoY to 27, with the company signing five new licenses in the quarter. Notably, this included three companies upgrading from Flexible Access Licenses, marking the first time such a transition had occurred. This also caught the attention of the analyst, who asked “Did that take you by surprise or were these customers that were getting to be particularly large for an AFA and so it was natural for them to upgrade?”

The company’s CEO, Rene Haas replied, “Yeah. Thank you for the question. We didn’t bring it up in our comments. We had a lot of good stuff to talk about this quarter, and I was trying to keep it as concise. But the AFA transition to ATA, thank you for calling that out. That’s a great trend for us. When we designed the program a number of years ago, that was absolutely the intent is that customers that launched into an AFA would ultimately go on to a total access license.When we designed the program a number of years ago, that was absolutely the intent is that customers that launched into an AFA would ultimately go on to a total access license.

What largely drives that, quite frankly, is the company that AFA start to get commercial traction in their business. Some of the AFA customers are early-stage companies. They may have an early exit or get acquired. But as they get larger and mature, we expect them to embrace Arm technology in a broader way. So I wouldn’t call it a surprise. I would actually call it an expected outcome that we have, and we’re really happy to see it. It’s great.”

Flexible Access Licenses

The Flexible Access Licenses grew by 6% YoY to 218. These agreements are renewed annually and over 50 were renewed in the quarter and 14 new agreements were signed with 6 net additions in the quarter.

Risks

The company also highlighted the risk in its prospectus that some of its customers support open-source RISC-V. This may not be a potential immediate risk to the business. However, it might be difficult for Arm to raise prices.

Arm China accounted for about 24% of revenue for the FY ending March 2023. The company said in its prospectus, “Neither we nor SoftBank Group control the operations of Arm China, which operates independently of us.” So, this is a potential political risk to consider if the US-China tensions escalate.

The company’s IPO lock-up period expired on March 12th, so volatility is likely in the coming months. The risk that Arm cannot hold the exuberant valuation it currently trades at post-lockup is very high. 

Arm was previously listed from 1998 to 2016 when it was taken private by SoftBank Group, and it holds about 90% of the outstanding shares. The high ownership of SoftBank is a significant risk to consider since SoftBank could slowly start to book profits on Arm Holdings once the IPO lock-up expiry is now over. Arm’s current valuation of $135 billion (90% is $122 billion) is significantly higher than SoftBank’s current market valuation of $85 billion.

Arm’s shares have doubled since its IPO in September 2023. Arm is currently trading at a forward P/S ratio of 41.9. As seen in the chart below, this is trading far higher than the other AI semiconductor companies. The 1-year forward for fiscal year ending in March 2025 is a PS ratio of  33.8, which still exceeds other AI-related semi companies – including Nvidia.

Qualcomm

As we look into Arm-based PCs, it’s worth noting that Qualcomm will be the first to release an Arm-based PC this summer with ETA of June. Qualcomm is a tough stock to own because it’s subject to licensing and IP lawsuits that the company most recently won, and anti-trust lawsuits that the company has lost. China adds complexity, as similar to Samsung and Apple, the OEMs use Qualcomm but ultimately seek to compete with Qualcomm where possible. This leads to IP battles and creates risk not present in other stocks. Interesting enough, Qualcomm is being sued by Arm following the acquisition of Nuvia as Arm alleges the IP deal it had with Nuvia should have been terminated at acquisition. What goes around, comes around.

For the most part, Qualcomm’s customers are frenemies. This is true for all of tech but especially Qualcomm. The tug-o-war between partners/competitors was noted in the most recent earnings call when an analyst asked the following:

“Tal Liani:

Thanks. I have two follow-ups on answers or questions you had before. The first one is Samsung. On one hand, there is a new contract. On the other hand, Samsung is going to use their own more in '24 versus '23. So net-net, are you expecting revenues of Samsung to go up or down in '24 versus '23? What are your expectations of share losses within — can you frame it for us?”

Management didn’t directly answer the question so I’m not going to quote their answer here other than to note the material concern to Qualcomm’s business model. Even as the company innovates on chips, chipsets and SoCs, the older products typically get replaced (where possible).

Qualcomm is not of interest for our portfolio right now as we would want to see more top line growth. Handsets have been in a decline, IoT is in a deep trough, yet automotive is surprisingly strong – which is all detailed below. However, Qualcomm is an important company to cover for AI edge devices and can be instrumental in helping us time our other investments.

From the most recent earnings call, the major takeaways for our purposes are timing for the Windows upgrade, Android’s roll-out for AI features, and China’s ramp in mobile that favors domestic OEMs like Huawei instead of Apple. Most importantly, as stated, the company is working with Microsoft on an Arm-based PC due out mid-2024. Details around this help to inform our thesis on AI-powered PCs, which was detailed here and here.

Brief Overview of the Financials:

In 2023, Qualcomm entered a trough similar to many other semiconductor companies. This was driven by mobile handsets and internet of things (IoT). Qualcomm’s IoT segment includes consumer virtual headsets and edge networking such as WiFi 7 broadband devices. In the most recent quarter, Qualcomm returned to positive growth of 5% after four quarters of negative growth, some as steep as (-24%) and (-23%).

The rebound will be strongest in the second half of CY2024 when Qualcomm returns to growth with an estimated 12.5% in the September quarter. Notably this estimate has come down since the last earnings report, when it was estimated to be 14.3%. The December quarter estimate is for 5.90%.

According to the earnings call, the September quarter will be seasonally stronger due to the anticipated Windows upgrade that is due to be released around the school season.

Here is what was said on the earnings call:

“We're tracking to the launch of products with this chipset tied with the next version of Microsoft Windows that has a lot of the Windows AI capabilities. We're still maintaining the same date, which is driven by Windows, which is mid-2024, getting ready for back-to-school, what we're excited about it is since we announced that Tech Summit showing the performance of the product and the AI capabilities, design traction continues to increase.”

On the bottom line, Qualcomm reported $2.75 non-GAAP EPS, beating estimates for $2.37. The company is returning to growth on the bottom line with the September quarter being the peak at 22% growth for EPS of $2.46. Last quarter, Qualcomm “returned $1.7 billion to stockholders during the quarter, including $784 million in stock repurchases and $895 million in dividends.”

Margins:

• Gross margin of 56.6% is in line with previous quarters
• Operating margin of 29.5% is higher than previous quarters. Discussion from Q&A is noted below.
• Net margin of 28% is higher than previous quarters.

More on Mid-2024 Timing

As mentioned above, the Windows upgrade is expected to hit mid-2024. There were some additional notes on timing:

Tom O'Malley:

Thanks for taking the question. Just passing on my congratulations to Akash as well. I just wanted to ask on the ASP side for Android. You're obviously kind of characterizing the market that's flattish into March, kind of the bottom in June and then improving from there. But you benefited from some good mix in the beginning of the fiscal year here. Could you talk about what you would expect from a mix perspective as you go to the back half? Would you see the same kind of strength on the ASP side that you've kind of seen over the past year? That would be really helpful to understand. Thank you.

Akash Palkhiwala:

Yeah. So if you think about premium flagship launches for our OEMs, a lot of the launches happen in the holiday time frame just before the holidays going into Chinese New Year as well. And so you've seen a lot of those happen. We do have some significant launches through the middle of the year, but obviously, the next big launch goes into the holiday season, starting with Apple and then going into the Android launches. So that's a typical cadence.”

China is a Problem for Apple

We outlined how BYD was becoming a problem for Tesla. According to commentary on Apple’s earnings call and Qualcomm’s earnings call this quarter, China’s preference for domestic OEMs is becoming a problem for the iPhone. In particular, Huawei is making a comeback. Below is mention that Huawei is performing well in the premium tier.

“Samik Chatterjee

[…] So just wondering if you can give us an update in terms of what you’re seeing from those customers? And if at all, Huawei and their reemerges in the market is starting to have an impact in terms of volume or market share for these customers as well in the context of your flat guide for them for quarter-over-quarter? Thank you.

Akash Palkhiwala

In terms of your comment on Huawei, really what we’ve seen since Huawei 5G launch is that the premium tier TAM in China has expanded. And so we’re continuing to see strong demand from our customers post that launch.”

There’s additional evidence that a Chinese OEM is gaining market share as a new customer emerged at 14% of revenue for Qualcomm compared to an estimated 20% from Apple.

“Ross Seymore

Great. And I guess for my follow-up, I noticed in the 10-Q, you had a new 10% customer, I think it was a 14% customer. I don't expect you to name who that is. But is that a reflection of the strong China demand that you talked about in the continuation of good future growth opportunities or was there any onetime aspect of that customer, whoever it may be popping up in the quarter?

Akash Palkhiwala

I think the you framed it in your first theory is a reasonable way of thinking about it.”

Per our write-up on Big Tech earnings, “Apple is facing competition from other smartphone companies in China due to foldable designs and advanced AI features. The company’s total revenue from China in the recent quarter was $20.8 billion, which missed estimates of $23.8 billion.”

Some of Qualcomm’s commentary is useful for if/when we build a position in Apple in anticipation of AI mobile devices. As of now, Apple faces a serious headwind with Huawei and Chinese OEMs. We saw the technicals flashing a few months back in a free analysis here and again here.

Snapdragon AI Platform Roll-Out:

Qualcomm’s Snapdragon 8 Gen 3 mobile platform is helping to bring generative AI to the edge with an AI engine that can run LLMs up to 20 tokens per second. It offers on-device AI such as live translate, interpreter and chat assist. Per management: “This marks the beginning of how gen AI will evolve the overall smartphone experience and highlights the significant opportunity for Snapdragon platforms.” 

The Samsung Galaxy S24 Ultra, GalaxS24 and S24 Plus is using the Snapdragon 8 Gen 3 mobile platform. Per management: “The Snapdragon 8 Gen 3 mobile platform is setting a new standard for on-device gen AI experiences for premium smartphones and powers all through flagship Android devices launched and launching this fiscal year.”

In addition, the Snapdragon X Elite will offer on-device gen AI and copilot for the upcoming Windows upgrade. There was a second mention of “mid-2024” for this release.

The Snapdragon X35 will also serve 5G-enabled industrial IoT devices equipped with generative AI, such as enterprise workflow, inventory management and warehouse applications (there are dozens or use cases). According to Qualcomm: “We continue to believe that industrial edge devices with connectivity, high-performance computing and on device AI will become one of our largest addressable opportunities fueled by the secular trends of digital transformation.”

Custom Oryon CPU Cores:

Qualcomm’s Snapdragon AI platform is powered by a new Arm-based CPU called Oryon. This effort began with the acquisition of Nuvia, a company that specializes in custom Arm silicon. This was important for Qualcomm to compete with Apple’s M1 chip, released in 2020 with more iterations since, such as M1 Pro, M1 Max, M2 and M3.

Prior to Nuvia, Qualcomm used Arm designs off-the-shelf with Cortex cores designed by Arm. The Oryon CPU will be the first 64-bit that Qualcomm has designed itself using an architectural license. Legally, only ARM themselves or companies Arm has sold a license to are allowed to design Arm CPUs. When Qualcomm bought Nuvia for its CPU design, Arm is asserting the license is no longer valid and is not transferrable since the company with the license no longer exits.

The importance of this is that Arm architecture on PCs is expected to help Windows PCs compete on performance and power efficiency with MacBooks. It could also spell trouble for Intel. Here are current benchmarks (benchmarks tend to be skewed in favor of one performance measurement rather than overall performance). This is also benchmarked against the M2 whereas the M3 on 3nm technology came out last Fall. According to Apple, the M3 is 15% faster than the M2 with efficiency cores that are 30% faster than what was benchmarked against the upcoming Qualcomm release.

With that said, Oryon is rumored to have power efficiency issues due to Qualcomm using cell phone PMICs. The power management integrated circuits (PMICs) are what manage and regulate the power in electronic components. By using cell phone PMICs, the CPU cores won’t run in the optimal efficiency range. In order to handle the needs of a laptop, Qualcomm is bundling together PMICs. In the very near-term, this means selling more Qualcomm PMICs, but in the medium-term, it means a competitor like AMD or Intel (or Nvidia) could crush Qualcomm on price and performance. The full write-up from SemiAccurate is worth a read. Here is what the independent analyst stated:

“Laptops have a large multiple of the board area of a cell phone, think more than 10x rather than a percentage. So a very expensive cell phone spec board just blew out costs for Oryon laptops. Whoops. Some OEMs SemiAccurate talked to were a tad peeved by this because it is entirely unnecessary, it is mandated solely by the force bundled PMICs. Allowing a suitable PMIC would also allow for a much cheaper PCB too but as you might guess, Qualcomm took a different path.”

Although we will have to wait until 2025 for AMD and Nvidia’s Arm-based laptops, the stage is being set for Qualcomm to stumble and this is something we track for portfolio purposes. To translate, Qualcomm could do well in 2024 given it will be the first to launch Arm-based Windows PCs for AI purposes but whatever lead Qualcomm gains in roughly 6 months time will be harder to maintain in 2025 and beyond as Qualcomm’s exclusive deal expires and more competition arrives.

Qualcomm will release its first smartphone processor with the Oryon CPU in late 2024. The Snapdragon 8 Gen 4 will feature custom CPU cores for the first time since 2016.

Note on Automotive:

The handset segment reported +16% growth and IoT reported (-32%) growth whereas the Automotive segment reported +31% growth.

It’s the smallest segment by revenue size at $598 million compared to handsets at $6.7 billion and IoT at $1.1 billion. However, what’s important to note is that Qualcomm’s automotive segment is growing when other pockets of Automotive are weak on an industry-wide basis. 

According to the Auto Investor Day, Qualcomm expects to have “greater than $4 billion in revenue in fiscal '26 and greater than $9 billion in revenue in fiscal '31.”

Here is what was stated on the call:

“And we already have some revenue from ADAS processing. You see a lot of cars for example, in China with both ADAS and autonomy with our processor, you see some of our customers in the United States of our processor. And I think that continues to grow as we get towards our 2026 revenue target, you’re probably going to see very healthy components of all of those elements.” 

Regarding the disconnect between Qualcomm’s growth in automotive versus the industry declining, the following was stated:

“Switching over to your second question on automotive. You should really think — the way to think about our automotive business is we're tied to the launch of new cars. Clearly, the industry is going through a transformation, digitization of cars, and we are right at the intersection of that transformation. We are we're benefiting our cars put in more infotainment content for experience within the car. More ADAS content comes into the car as well.

And really, we get to benefit from all those intersection points in the car, and we're increasing the content as new cars launch. So that's the maybe a disconnect between some of our peers what they're seeing and what we're seeing. Stepping back, I mean, clearly, this is an industry that's going through some shorter-term dynamics, so we'll be closely monitoring it. But when you step back, our technology, our position, our products look really good, and we're excited about where we're going.”

Nvidia and AMD could strong ARM Qualcomm

The efficiency shown by the M1 and M2 chips from Apple has resulted in a long battery life and high performance per watt. Apple’s laptops like the M2 Max Macbook Pro can compete with discrete graphics and is better suited for AI processing than laptops with x86 processors. This has led to Apple doubling its market share since the M1, and has caught the attention of Nvidia and AMD. Qualcomm has an exclusive through 2024, which leaves 2025 as the year the world’s top design companies can release an Arm-based PC. According to Reuters, this is exactly what they plan to do.

In addition to Qualcomm’s controversial use of mobile PMICs, which could alter the benefits of an Arm-based PC in terms of power requirements, Nvidia and AMD are more equipped to build advanced AI features into CPUs and devote on-chip resources for AI-enhanced software (need I go further into how Nvidia and AMD will potentially beat Qualcomm on advanced AI features? This one is a tad obvious)

Where the rubber meets the road is that x86 applications have a mature ecosystem and is ubiquitous whereas code for Arm-based Windows is far less supported. If Nvidia and AMD are getting involved, then they must be envisioning the power requirements for AI will be enough of a motivating factor to push forward efforts for Windows Arm-based code.

Conclusion:

We are not interested in Qualcomm or Arm as a portfolio position at this time, rather we are tracking these companies more closely as they will help to bring AI to the edge with Arm-based PCs. This will be timed to an AI-focused release for Windows in mid-2024. There is also quite a bit of excitement around Arm at the moment. For the most part, our firm does not participate in IPOs as the vast majority trade below their opening price after the lockup expires. Arm’s valuation is particularly shocking as it exceeds even Nvidia. We find it advantageous to take our time and buy post-lockup, especially given Arm CPUs dominate 99% of mobile and it’s procured very little revenue compared to mobile heavy hitters in hardware and software. What’s also of interest to our portfolio is that Qualcomm may stumble given the mobile PMICs being used, and in that case, our favorites AMD and Nvidia could have an opening to dominate come 2025.

The overarching theme is that Edge AI is approaching and we want our positions to be aligned as closely as possible given client revenue has been weak for semis across the board. It will be the perfect recipe when client revenue segments return to growth, combined with ongoing data center strength. We want to be positioned when this happens for otherwise strong semiconductor companies that are currently a “tale of two cities” – weak PC and mobile segments detracting from strong data center/AI segments.

Resources:

• In 2021, the IOF covered Arm in a Forbes analysis.
• Broadcom: $10B in AI Revenue This Year Plus Software is Rapidly Accelerating
• Marvell Q4: Data Center Strong but AI Slow to Materialize
• Super Micro Q2 2024 Earnings: The AI Bullet Train

Microsoft (MSFT)

Microsoft topped on February 13th, making a series of lower highs while the S&P 500 (SPX) continued higher. We now have Tesla, Apple, Google and Microsoft not participating in the current push higher, which is a big warning for the bulls. Not only were these stocks market leaders in 2023, but they account for ~18% of the total weighting within the S&P 500. This is a large weight around the broad market, and a divergence that should not be ignored.

Regarding MSFT, we have logged significant gains, moving it from a 8% position back to a 2% position. The valuations are at extremes, and the technical picture is concerning. Note below how we have two degrees of 5 wave patterns that started off the 2022 low. This is a mature pattern, and likely setting up for a pullback. Below $397 will be the first warning that a downtrend has started. Once we go below $365, the top will most likely be confirmed and we will set up downside targets to buy.

Nvidia (NVDA)

Nvidia started Friday up over 6% and ended the day down -5.5%. This is called a bearish engulfing candle, and can be visually seen in the below chart (the red arrow). This type of candle pattern tends to show up around trend reversals. What makes this one more notable is the fact that it happened on such heightened volume. In fact, this was the most trades shared in a day since the August, 2023 top, which started 2 month correction.

We have been patiently waiting for a prolonged reversal of this market leader. We believe that if it does not happen here, it should happen after we push towards the $1000-$1100 region on one more push higher. As long as we hold $784, the potential for another swing higher is possible. Below this level and we will start setting up downward targets to buy.

Bitcoin (BTCUSD)

We have been waiting for Bitcoin to go vertical, and it appears to have done so over the last few weeks. The vertical move tends to mark the halfway point of the uptrend, which puts our targets over the $100,000 region. However, we should see a pullback before continuing higher.

Note the weekly chart below. The Detrend Oscillator is in the same position as the 2021 peak. This oscillator loves the reverse at prior peaks and troughs. It’s at this position while the Composite Indicator is making a lower high. In other words, price is pushing higher with less momentum. These are warnings that a breather is likely to happen.

If we do pullback, we will be targeting the $57,000 region to add to our position. In order to continue higher, we must hold $40,000. Below this level and the uptrend we have been tracking will likely be over.

Recommended Reading:

• Nvidia Fiscal Q4: Yet Another Big Beat and Raise
• Nvidia Earnings Preview: 239% is the Revenue Growth Peak (for now)
• Positions Update: Microsoft, Nvidia, and Bitcoin
• Big Tech Q4 Earnings: Capex Increases

Marvell’s Q4 was primarily in line with consensus, though GAAP EPS reported a rather large miss. The Q1 forecast across the board was very weak, with revenues guided 16% below consensus with margins firmly negative.

Q4 saw a marginal YoY increase in revenue, breaking a three-quarter string of declining growth, but Marvell guided for a (13%) YoY decline in revenue in Q1 at midpoint, suggesting that it is not yet out of the woods with weak growth in all of its end markets except for data center. Management dangled some carrots in the earnings call, primarily that Q1 would mark the bottom and that qualifications for ASICs are now moving to production for full ramp in FY26 (one year from now).

Revenue and EPS:

• Q4 revenue was $1.43 billion, beating estimates by $10 million, and representing YoY growth of 0.7%.
• Q1 revenue guidance missed at $1.15 billion, +/-5%, representing a YoY decline of (13%) at midpoint. As stated above, this is 16% below consensus with expected revenue of $1.37 billion.
• FY24 revenue was $5.51 billion, a decline of (6.9%) YoY. Prior to the report, analyst consensus was for an acceleration in FY2025 to 11.1% YoY to $6.11 billion and 19.9% YoY to $7.33 billion in FY2026. The acceleration will likely still materialize but could be delayed given the weak Q1.
• Q4 adjusted EPS was $0.46, meeting estimates and representing flat YoY growth. GAAP EPS was ($0.45), missing estimates for $0.00.
• Management guided for Q1 EPS of ($0.23) +/- $0.05 and adjusted EPS of $0.23 +/- $0.05. This is a miss compared to consensus for $0.40 adjusted EPS.
• FY24 adjusted EPS was $1.51, a decline of (40.4%) YoY. GAAP EPS was ($1.08), compared to ($0.19) in FY23. Previously, EPS was expected to rebound to 33.1% YoY growth to $2.01 in FY2025 and 40.4% YoY growth to $2.82 in FY2026. These estimates may come down given the weaker Q1 guide.

Margins:

Margins were weak, as Marvell reported a negative GAAP operating margin whereas it had guided for a thinly positive operating margin in Q4.

• Q4 GAAP gross margin was 46.6%, compared to 47.5% in the year ago quarter. The adjusted gross margin was 63.9%, up from 60.6% in the previous quarters. Per management last quarter: The CFO, Willem Meintjes, said in the earnings call, “Our forecast for this large sequential improvement is driven by expectations of a significantly stronger product mix and our ongoing cost optimization activities. Looking forward, we expect that product mix as well as the overall level of revenue will remain key determinants of our gross margin in any given quarter.”stronger product mix and our ongoing cost optimization activities. Looking forward, we expect that product mix as well as the overall level of revenue will remain key determinants of our gross margin in any given quarter.”
• Q4 GAAP operating margin was (2.3%) versus its guide for 1.6% at midpoint. This compares to 1.6% in the year ago quarter. GAAP operating margins for Q1 are expecting to fall further, with management guiding Q1’s GAAP operating margin at (12.3%) at midpoint, a 1000 bps sequential decline. Regarding GAAP OPM, management stated this includes “stock-based compensation, amortization of acquired intangible assets, restructuring costs and acquisition-related costs.” Stock based compensation was $155.3 million, or 11% of revenue.
• Adjusted operating margin was 33.8% for adjusted operating profits of $482.6 million. This fluctuates due to seasonality in payroll taxes and employee salary increases.   
• Q4 GAAP net margin was (27.5%), compared to (1.1%) in the year ago quarter and (11.6%) in Q3. Adjusted net margin was 28.2% for adjusted net profits of $401.6 million.
• FY24 GAAP gross margin was 41.6%, compared to 50.5% in FY23. Adjusted gross margin was 61.2% compared to 64.5% FY23.
• FY24 GAAP operating margin was (10.3%), compared to 4% in FY23. Adjusted operating margin was 29% down from 36% in the previous year.
• FY24 GAAP net margin was (16.9%), compared to (2.8%) in FY23. Adjusted net margin was 23.8% down from 30.8% the previous year.

Cash and Debt:

• Q4 operating cash flow was $547 million, representing a 38.3% margin.
• FY24 operating cash flow was $1.37 billion, an increase of 6% YoY.
• Cash, equivalents and short-term investments totaled $950.8 million.
• Debt totaled $4.16 billion. Gross debt-to-EBITDA ratio was 2.19X and net-debt-to-EBITDA ratio is 1.69X. This has been slightly trending down but is still a concern.

Inventory at the end of the fourth quarter was $864 million, down by $77 million from the prior quarter. DSO was 77 days, decreasing by a day from the prior quarter. 

The company returned $52 million to shareholders through cash dividends and repurchased $100 million of our stock during the fourth quarter, double from the prior quarter. The company expects to further increase repurchases in the first quarter of fiscal 2025.

Marvell's Board approved the largest repurchase authorization in company history, increasing the current plan by $3 billion, for a total available authorization of $3.3 billion

Key Segments:

Data Center:

Data center revenue was the strongest point of the report, with growth at 54% YoY in Q4, breaking a four-quarter string of declining growth. Data center revenues increased 38% QoQ, ahead of the mid-30% range management had guided and a sharp acceleration from 21% QoQ growth in Q3 and 6% QoQ in Q2.  

Data center accounted for 54% of revenue in the fourth quarter, a large increase from 39% in the prior quarter. According to the opening remarks, it was a mix of primarily traditional data center and some AI driving this increase: “The strong revenue growth in the quarter was driven by the cloud portion of our data center end market. While AI has been a key growth driver, I am pleased that our standard cloud infrastructure revenue has also grown every quarter, and we see that continuing next year. Our 800-gig PAM solutions led our growth in the fourth quarter. We also benefited from higher sequential demand for our storage products as that portion of our data center end market continues its recovery. Revenue from our Teralynx, Ethernet switches also grew sequentially in the quarter.”

Management said data center revenue for next quarter will be in the low single digits QoQ: “Turning to the first quarter of fiscal 2025. We expect our overall data center revenue to grow in the low single digits sequentially on a percentage basis. We expect revenue from both AI and standard cloud data centers to continue to grow sequentially. We project our [ Electro ] optics revenue to continue to be strong, and we also expect to benefit from the initial shipments of our cloud optimized AI silicon programs. Partially offsetting this growth, we are projecting a more than seasonal sequential decline in revenue from enterprise on-premise data centers.”

The main carrot that was dangled on data center as it pertains to AI is for H2 growth. I’ve included that commentary below.

Enterprise Networking & Carrier Infrastructure – Steep declines in Q1, Mgmt says will mark the bottom

• Enterprise Networking revenue was $265M (down 28% YoY, down 2% QoQ).
• Enterprise is expected to decline 40% QoQ in Q1.
• Carrier Infrastructure (5G) revenue of $170M (up 38% YoY, down 46% QoQ).
• Carrier is expected to decline by 50% QoQ in Q1.

Per the comments on the call, Q1 is expected to be the bottom.

“As we have been communicating, these end markets [enterprise and carrier] have been dealing with a period of soft industry demand. As a result, both were down sequentially in the fourth quarter and we expect them to decline again in the first quarter […] Looking ahead, we expect revenue declines in these end markets to be behind us after the first quarter and forecast a recovery in the second half of the fiscal year. Longer term, these are large and enduring end markets, which are critical to the global economy. As a result, we expect both of these end markets to eventually return to contributing over $1 billion each in revenue on an annual basis once demand normalizes, and we begin to realize the benefits of upcoming Marvell-specific product cycles.

Consumer:

Consumer revenue of $143.9M (down 20%, down 15% QoQ). Consumer is expected to decline (70%) QoQ in Q1.

Per management remarks: “This forecast reflects the completion of deliveries for an end-of-life program in the prior quarter as well as significantly weaker demand from the game console market.”

Automotive:

Automotive/Industrial revenue of $82.3M (down17% YoY, down 23% QoQ). This is a small segment for Marvell that has been impacted by the softness in EVs. For the fiscal year 2024, automotive was up double digits YoY. It’s expected to be flat QoQ in Q1.

Earnings Call:

AI Revenue Ramping in H2 & Beyond

Marvell has to find a way to impress Wall Street on AI despite the fact that it’s ramping much slower than its peers. If we read between the lines, a run rate of about $500 million will happen early FY2026. That’s my rough math, but given commentary in the opening remarks, we are looking at $200M per quarter right now on AI networking/optics and can expect $200M by Q1 FY2026 on ASICs/compute. So, if we assume AI networking grows by 50% this year, we arrive at $500M in about 12 months from now.

Here's the commentary I’m basing that on – it’s the second paragraph that has more information on AI revenue specifically:

“We now have a clear view of demand for both this fiscal year as well as fiscal 2026. We have been working closely with our suppliers and are confident that we have secured capacity for the ramp. With the visibility we now have for these programs, along with many new opportunities, we are very excited about the potential scale of long-term revenue for Marvell from this business. As the initial set of design wins reach its full run rate, we expect annual revenue from cloud optimized silicon has the potential to rival our fast-growing data center optics business, which, for reference, grew to over $1 billion in fiscal 2024.”

Additionally, management offered a few more breadcrumbs as to AI revenue, such as: “AI was a key driver of our data center growth in fiscal 2024, contributing over 10% of total company revenue, well above our initial forecast. This was a substantial increase from approximately 3% in the prior year. Our momentum accelerated throughout the fiscal year with AI revenue well over $200 million in the fourth quarter, driven mostly from Optics […] In fact, as our cloud optimized AI silicon programs reach high-volume production, we expect our overall cloud optimized revenue to exceed $200 million exiting the fourth quarter. As a result, on a run rate basis, this momentum would put our overall cloud optimized silicon revenue above the annual $800 million target we had provided at our last Investor Day. And with the full year of contributions in fiscal 2026, we expect to be way ahead of the prior target. In aggregate, we see a favorable setup for the second half of this fiscal year, driven by continued growth from our data center end market, ongoing growth from automotive, and a recovery in carrier, enterprise and consumer.”

Later in the Q&A, this was the better question in terms of discussing potential AI revenue in custom silicon moving from qualification to production:

Question
Harlan Sur (Analysts)

Matt, you mentioned the initial shipments of your AI ASIC program. Can you just clarify because I know last you updated us, these programs were in qualification. So have you guys passed Qual on both these programs? And is it sort of the initial start of the full production ramp? Or maybe you're still in Qual, but you've got enough line of sight to passing the Qual just given you're at the tail end of this process? And maybe more importantly, have you guys secured the follow-on AI programs for these two initial projects?

Answer
Matthew Murphy (Executives)

So yes, we are in the initial start of the production ramp on both products. And then as far as the follow-on, like I said, the opportunity funnel we see across all of the various opportunities right now is significant, and we're involved in, we believe, we think, every single one of them. So yes, and there'll be more to come sort of at our AI day, but I would just say our 3-nanometer funnel and our 3-nanometer hit rate and design win rate is very encouraging and it really gives us this tremendous confidence in where this business is headed. It also has a side benefit by driving this advanced technology for the custom ASIC side, is it's pulling along the technology development that benefits all the other businesses in Marvell, like our high-performance switching, our DSP for optics, et cetera. So there's actually kind of a virtuous cycle happening where being at that bleeding edge is now we're able to show our other solutions that interoperate with this custom silicon, really a best-in-class road map there.

Q1 is the Bottom

The CFO later reiterated that Q1 will be the bottom:

“Yes, so we're really working with customers to focus on Q1 being the bottom, really confident that, that's the bottom. And then we see growth resuming in the second half across enterprise networking, carrier and consumer so really just trying to make sure that we put this behind us really quickly and see growth in the second half.”

Conclusion:

As I left the Marvell call and moved along to join the Broadcom earnings call, there is no doubt which company is stronger right-here, right-now. It’s Broadcom. Marvell has a strong product story but it’s in a sea of AI whales that are ramping quickly. The $500M in AI revenue per quarter (run rate) estimated to be reported in about 12 months time is a strong start, but the stock is trading quite high. Also, the need to impress the market is high and Marvell management is trying hard with this very-forward-looking commentary.

At the right price, Marvell will make a great stock. But unfortunately, it’s the opposite which is that at this valuation, we plan to sell Marvell. The PE Ratio is similar to PS Ratio, which is that it’s trading in a range that the stock struggles to maintain.

In previous quarterly webinars, we’ve pointed out that Marvell is our weakest stock in an environment where rates remain elevated given its debt-to-equity ratio and GAAP profitability issues. Meanwhile, Nvidia’s PS Ratio and PE Ratio is near it’s October 2022 lows and Broadcom stated today it’s expecting $10B in AI Revenue this year, or 20% of its total revenue for this calendar year compared to Marvell’s 13%. Given Q1 is quite troublesome for Marvell with steep sequential declines and AI revenue that is likely priced in, we will look to trim or exit and buy lower. You can also expect us to re-allocate some of this to AVGO in the meantime. Or, perhaps, we will buy more Nvidia as we go along. Overall, we see both as stronger choices at the moment, and will revisit Marvell when it’s either cheaper or moving quicker in terms of its AI growth trajectory.

Recommended Reading:

• CrowdStrike Q4: RPO Surges, Net New ARR Impresses, GAAP Margins Strengthening
• Broadcom: Networking/ASICs Giant and The Second Largest by AI Revenue
• Nvidia Fiscal Q4: Yet Another Big Beat and Raise
• Nvidia Earnings Preview: 239% is the Revenue Growth Peak (for now)

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.

Recommended Reading:

•  Marvell Q4: Data Center Strong but AI Slow to Materialize
• CrowdStrike Q4: RPO Surges, Net New ARR Impresses, GAAP Margins Strengthening
• Broadcom: Networking/ASICs Giant and The Second Largest by AI Revenue
• Nvidia Fiscal Q4: Yet Another Big Beat and Raise