Earnings Season Recap #27

We’ve curated core ideas and lessons from the legendary investor Sam Zell, who recently passed away at the age of 81. Also, this dispatch includes quarterly highlights and curated quotes from HEICO and NVIDIA.

Sam Zell, who recently passed away at the age of 81, was a trailblazing investor renowned for his contrarian approach and ability to spot undervalued assets. With precise research and a knack for identifying emerging trends, he consistently delivered impressive returns.

His adaptability and philanthropic endeavors further define his influential presence in the investment world. Sem Zell inspired a new generation of investors to challenge norms and seize untapped opportunities. In his memory, we want to highlight his core ideas and lessons from his life and career.

Record-breaking results, the foundation for continued growth and market share gains, and the consistent compounding for 30 years.

Revenue +28%
*Flight Support +28%
*Electronic Technologies +27%
EBIT +29%
*margin 22.8% (22.7%)
EPS +23%

Record-breaking results
I continue to be very optimistic about the future for HEICO and our over 9,000 team members. I'd like to summarize the highlights of the second quarter fiscal '23 results. They are record results. Consolidated second quarter fiscal '23 net sales represent record results for HEICO, driven principally by record net sales within the Flight Support Group. This arose mainly from continued rebound in demand for commercial aerospace products and services and the contributions from our fiscal '23 and '22 acquisitions. Consolidated operating income and net sales in the second quarter of fiscal '23 each improved by 28% as compared to the second quarter of fiscal '22. These results mainly reflect 10% quarterly consolidated organic net sales growth as well as the impact from some acquisitions. – Laurans Mendelson, Chairman & CEO (00:03:35)

Net debt and balance sheet
Our net debt, which is total debt less cash and cash equivalents of $627.5 million as of April 30, '23 compared to shareholders' equity ratios, was 21.9% as of April 30, and this compared to 5.7% as of October 31, '22. Our net debt-to-EBITDA ratio was 0.4x, less than 1x, as of April 30, '23, and that compared to 0.25x as of October 31, '22. Both times were less than 1x EBITDA. The increase in our debt ratio in the first 6 months of fiscal '23 principally reflects the impact from financing the purchase of Exxelia in January '23. – Laurans Mendelson, Chairman & CEO (00:05:22)

Cash flows and working capital
Cash flow provided by operating activities was $77.8 million in the second quarter of fiscal '23, and that compared to $96.8 million in the second quarter of fiscal '22. The cash flow provided by operating activities in the second quarter of fiscal '23 reflects an increase in working capital principally driven by an increase in inventory to support our increased consolidated backlog. We continue to forecast strong cash flow from operations for fiscal '23. As a personal comment, I always consider increase in inventories an indication of future growth in sales, so the increase in the inventory does not concern me. – Laurans Mendelson, Chairman & CEO (00:06:47)

Foundation for continued growth and market share gains
Continued inflationary pressures and lingering supply chain disruptions stemming from the COVID-19 pandemic may lead to higher material and labor costs. During fiscal '23, we plan to continue our commitments to developing new products and services, further market penetration and an aggressive acquisition strategy while maintaining our financial strength and flexibility. We believe that our ongoing conservative policies, a strong balance sheet and a high degree of liquidity enables us to continuously invest in new research and development and to take advantage of periodic strategic inventory purchasing opportunities, as well as executing on our successful acquisition program. All these collectively position HEICO for continued growth and market share gains. – Laurans Mendelson, Chairman & CEO (00:19:14)

The reason why HEICO exist
We really believe that this combination is a great win for our customers because with expanded capacity and we believe that we'll be able to offer customers better pricing, lower pricing, more products and more efficiency. So we look at it not so much as a win for HEICO and Wencor, which I think it will be, but really a big win for the customers and the industry. As you know, HEICO exists because its pricing is below the OEM, and that's the reason that they buy our products, we're 30%, 40% below. And this will give us the capacity to give even more value. – Laurans Mendelson, Chairman & CEO (00:26:55)

Consistent compounding for 30 years
We try to grow 15% to 20% bottom line on an annual basis in this compound. We have done that pretty consistently for the past 30 years, and according again to our projections, we believe that we will be able to, in '24, grow within that 15% to 20% increase. Now of course, everything is dependent upon market conditions and everything else. But based on everything we know today, this acquisition will permit us to continue to compound at least in '24, and our leverage will be below 2x when we get to the end of '24. So I presume that we will continue to make smaller acquisitions as long as the leverage does not go up. – Chairman & CEO (00:43:57)

Strong sequential growth driven by Data Center, capital allocation and buybacks, outlook for the second quarter, and the start of a 10-year transition.

Revenue -13%
*Data Center +14%
*Gaming -38%
*Professional Visualization -53%
*Automotive and Embedded +114% 
EBIT +15%
*margin 30% (20)
EPS +28%

Strong sequential growth driven by Data Center
Q1 revenue was $7.19 billion, up 19% sequentially and down 13% year-on-year. Strong sequential growth was driven by record data center revenue with our gaming and professional visualization platforms emerging from channel inventory corrections. Starting with Data Center. Record revenue of $4.28 billion was up 18% sequentially and up 14% year-on-year on strong growth of our accelerated computing platform worldwide. Generative AI is driving exponential growth in compute requirements and a fast transition to NVIDIA accelerated computing, which is the most versatile, most energy-efficient and the lowest TCO approach to train and deploy AI. – Colette Kress, CFO (00:02:06)

Gaming
Gaming revenue of $2.24 billion was up 22% sequentially and down 38% year-on-year. Strong sequential growth was driven by sales of the 40 Series GeForce RTX GPUs for both notebooks and desktops. Overall end demand was solid and consistent with seasonality, demonstrating resilience against a challenging consumer spending backdrop. [...] Generative AI will be transformative to gaming and content creation from development to runtime. [...] There are now over 1,600 games on GeForce NOW, the richest content available on any cloud gaming service.  – Colette Kress, Executive VP & CFO (00:12:41)

Pro Visualization and channel inventory
Moving to Pro Visualization. Revenue of $295 million was up 31% sequentially and down 53% year-on-year. Sequential growth was driven by stronger workstation demand across both mobile and desktop form factors, with strength in key verticals such as public sector, health care and automotive. We believe the channel inventory correction is behind us. – Colette Kress, Executive VP & CFO (00:15:26)

Margins and capital allocation
GAAP gross margins was 64.6%. Non-GAAP gross margins were 66.8%. Gross margins have now largely recovered to prior peak levels as we have absorbed higher costs and offset them by innovating and delivering higher-valued products as well as products incorporating more and more software. Sequentially, GAAP operating expenses were down 3% and non-GAAP operating expenses were down 1%. We have held OpEx at roughly the same level over the past 4 quarters while working through the inventory corrections in Gaming and Professional Visualization. We now expect to increase investments in the business while also delivering operating leverage. We returned $99 million to shareholders in the form of cash dividends. At the end of Q1, we have approximately $7 billion remaining under our share repurchase authorization through December 2023. – Colette Kress, Executive VP & CFO (00:18:41)

Outlook for the second quarter
Total revenue is expected to be $11 billion, plus or minus 2%. We expect this sequential growth to largely be driven by Data Center, reflecting a steep increase in demand related to generative AI and large language models. This demand has extended our Data Center visibility out a few quarters, and we have procured substantially higher supply for the second half of the year. GAAP and non-GAAP gross margins are expected to be 68.6% and 70%, respectively, plus or minus 50 basis points. GAAP and non-GAAP operating expenses are expected to be approximately $2.71 billion and $1.9 billion, respectively. GAAP and non-GAAP other income and expenses are expected to be an income of approximately $90 million, excluding gains and losses from nonaffiliated investments. GAAP and non-GAAP tax rates are expected to be 14%, plus or minus 1%, excluding any discrete items. Capital expenditures are expected to be approximately $300 million to $350 million. – Colette Kress, Executive VP & CFO (00:20:01)

The iPhone moment
The integration of guardrails and alignment systems with reinforcement learning human feedback, knowledge vector databases for proprietary knowledge, connection to search, all of that came together in a really wonderful way. And it's the reason why I call it the iPhone moment. All the technology came together and helped everybody realize what an amazing product it can be and what capabilities it can have. And so we were already in full production. – Jensen Huang, Co-Founder & CEO (00:26:22)

The start of a 10-year transition
In the future, it's fairly clear now with generative AI becoming the primary workload of most of the world's data centers generating information, it is very clear now and the fact that accelerated computing is so energy efficient, that the budget of a data center will shift very dramatically towards accelerated computing, and you're seeing that now. We're going through that moment right now as we speak, while the world's data center CapEx budget is limited. But at the same time, we're seeing incredible orders to retool the world's data centers. And so I think you're seeing the beginning of, call it, a 10-year transition to basically recycle or reclaim the world's data centers and build it out as accelerated computing. – Jensen Huang, Co-Founder & CEO (00:29:15)

Competition and value proposition
We have competition from every direction. Start-ups, really, really well funded and innovative start-ups, countless of them all over the world. We have competitions from existing semiconductor companies. [...] NVIDIA's value proposition at the core is that we are the lowest cost solution. We're the lowest TCO solution. And the reason for that is because accelerated computing is 2 things that I talk about often, which is it's a full stack problem. [...] And the amount of engineering and distributed computing, fundamental computer science work is really quite extraordinary. It is the hardest computing as we know. And so number one, it's a full stack challenge and you have to optimize it across the whole thing and across just a mind-blowing number of stacks. – Jensen Huang, Co-Founder & CEO (00:32:46)