Marvell Technology (MRVL) Blows Past Competitors

Even non-engineers can appreciate the engineering of Marvell Technology Group (MRVL). After making a number of technological break-throughs in 2008 and earlier in 2009, revenues are ramping very quickly as products containing their semiconductor chip systems are being built.

For an overview of Marvell technology, see Marvell Under the Hood. For my past analyst conference summaries, see Marvell Analyst Conference Summaries.

Revenue for the quarter ending October 31, 2009 was $803.1 million, up 25% sequentially from $640.6 million and up 2% from $791.0 million year-earlier.

Net income of was $201.6 million, up 245% sequentially from $58.5 million and up 183% from $70.9 million.

EPS (earnings per share) were $0.31, up 244% sequentially from $0.09 and up 181% from $0.11 year-earlier.

Cash and equivalents ended at $1.46 billion. Cash flow from operations wa $203.5 million. $196 million free cash flow. Inventories rose to $239 million to deal with areas of tight supply. Long term liabilities are $174.3 million.

Non-GAAP, which excludes $34.4 million in stock-based compensation, $26.5 million amortization, $1.9 million restructuring, but adds back in the $32.6 million tax benefit: net income $231.8 million. EPS $0.35.

Guidance for fourth fiscal quarter 2010 was $802 to $850 million in revenues. Networking and storage sequential growth, with normal seasonal slowdown of wireless. 58.5% non-GAAP gross margin. $235 million non-GAAP operating expenses. $254 million operating profit. Other income $1.5 million. Tax $12 million. 670 million diluted shares. $0.33 to $0.39 non-GAAP EPS. $150 million free-cash flow. GAAP EPS about $0.09 less than non-GAAP.

Analyst Questions and Answers (summary):

Hard drive market dynamics? First quarter 2010 should continue to be helped by low cost of PCs. Our hard drive customers are optimistic.

Gross margin improvement and mix? We don't provide gross margin by end-market segments. Mobile and wireless end markets experienced very good growth, and your margin estimates for that segment may be off.

China Mobile processor market size? PXA920 is very specific, high volume, high performance for standards of China market. It is state-of-the art smart phone solution, but also cost effective enough for the mass market. Our aspiration is higher than any number anyone is throwing out yet.

Sustainability of gross margins? Semiconductor business gross margins should be on high end as prices go down, to offset other expenses. This is a fundamental shift. The numbers we have are fair numbers and we plan to maintain them as long as we can, and best-in-class semiconductor companies will need to achieve this range.

Are your customers in hard drives adding to inventories? We are on a consignment basis, so they do not need to build inventories of our chips. Full feature PCs, even laptops, are now under $500, which is building demand, especially in emerging economies.

Dividends? We do not believe we are out of the economic downturn, so it is too soon to talk about distribution of cash. Our bias is to have more cash than we need in order to not be at the mercy of banks.

China business going forward? We are optimistic about our work for China Mobile; we have been working with them for 2 years. PDS/CDMA 3G is the pride of China. We believe it will be the main technology in China going forward, so we expect a very strong second half of next year.

Visibility is much improved. Inventory is leaner. We have had some shortages and longer lead times, so customers are giving us more visibility.

O-phone success detail? PXA920 will be used by many OEM cell phone makers for the China market; not all of them will be O-phones. The main chip is the most highly developed ever, but we also have the chip set solutions (power, wi-fi, etc.) that go with this. Revenues will start to ramp in the second half of next year; not contributing yet.

Bluetooth Wi-Fi combo part growth? We are very happy with traction with this device is finally taking off. The ramp now is the first generation device, a second generation is in design now. Any device requiring Bluetooth and WiFi is a potential market.

Reviewed how integration of systems on a chip help everyone, including the OEMs and end customers, while lowering everyone's costs despite increasing Marvell's gross margin.

ARMADA initial end markets? Across the board. Chips range from low end to high end. The run on all the ARM software in the market. So the market is any consumer device from HDTV decoders to picture frames to Internet portals like netbooks to automotive display consoles.

Marvell Technology (MRVL) Under the Hood

About half of Marvell Technology Group (MRVL) revenue comes from its disk drive segment. It does not make hard drives; it makes the chips that enable the drives read and write data and communicate with the rest of the computer. This was Marvell's first business and it now dominates that market.

Like most technology companies, Marvell had a rocky last half of 2008 and first half of 2009. Even after a 23% sequential revenue increase in its latest quarter (which ended August 2, 2009; second quarter fiscal 2009) to $640.6 million, its revenue was down 24% from the year-earlier quarter. On the other hand, Q2 2008 had been a blockbuster quarter, with Marvell proving that its investments in new technologies could pay off.

While Marvell may yet expand its market share in the hard disk market, and that market may expand as nations like India and China continue to expand their technology sectors, to understand (or at least guess at) Marvell's future revenue, profits, and stock value you must look at the other 50% of the company. This revenue already was approximately $320 million in the latest quarter, yet many of its products are just beginning to produce revenue or are still in development.

The networking end market accounted for about 20% of revenue in the most recent quarter. This segment includes the chips that go into network switches and routers. This is a very big market, and highly competitive, but Marvell has plenty of room to grow its market share.

Mobile and wireless networking is also an important end market. Here the combined analog and digitial expertise of Marvell, which are now integrated onto single chips, comes into play. One new type of product using Marvell chips takes a 3G signal usually used for cell phones and broadcasts Wi-Fi for local wireless internet connectivity.

Marvell also makes chips to control printers. According to HP printer sales have not been so great this last year, so expect this segment to rebound when people's legacy printers start dying.

Most fascinating are Marvell's application and communication processors (based on Kirkwood and Discovery Innovation). These are designed for the type of high performance users now expect from mobile computing devices and use very low amounts of power. More important, Marvell is able to put these processors on a single chip with one or more of its other technologies. It already has chips that combine Bluetooth and Wi-Fi capabilities. Rather than just sell discrete chips, it works with customers to design whole systems-on-a-chip. Other companies do this, but Marvell is the leader in the field.

Some of this last year's profits have been made by cost-cutting, particularly in Research and Development. But the key to profitability has been the model of integrating functions on a chip for customers particular products. To paraphrase management: We will continue to have above-industry margins as long as we are able to build products that our competitors cannot match.

Marvell has video processing capabilities. It says it has many design wins, but does not announce anything until its customers make their own announcements. You can imagine what might be coming out in 2010: devices with a digital processor, video processor, and either wireless or wired communications capabilities all on a single chip. Which will lower costs for consumers, driving unit sales, while allowing both the OEM and Marvell to maintain high margins.

The usual risks and uncertainties apply in the highly competitive technology field.

See also my August 27, 2009 Marvell analyst conference summary.

And keep diversified!

Marvell site

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Marvell's Huge Research and Development Budget

Marvell (MRVL) reported fiscal Q2 2008 earnings yesterday (August 23, 2007) with a GAAP loss of X or x per share. The stock lost 10% of its value in trading today. I believe some traders were hoping for a short-term pop because of rumors that a hedge fund had taken a position and that Marvell produced one part for Apple's iPhone cell phone. They overlooked the elephant in the room: Marvell's R&D (research and development) spending for the quarter. In fact the short-term sell-side analysts probably see the R&D budget as a negative. Here I'll focus on the future and the R&D expenses. For more on the past, see my notes on the Marvell analyst conference.

Marvell spent an astonishing $236 million on R&D in the quarter. Its revenues for the quarter were $657 million. So R&D was 36% of its budget. Compare that with, say Intel, which spent 30% of its revenues on R&D last quarter; or a more direct competitor, Linear Technology, which spent $47 million on R&D, or 17.5% of revenue.

It looks to me like Marvell is girding for war. They are not going to try to become the world's sole supplier of semiconductor chips, but they are going after a lot of cutting-edge, high volume, high margin business.

Some results are already rolling in. In May management guided Q2 revenues to $645 million; instead they came in at $657. Part of the differential probably came from chips that went in iPhones, but you have to remember that Marvell is already a big company. In fact it has pretty well made its intention clear: it is going after the 3G high-end phone market, not just Apple's tiny fraction of it. Last year it bought Intel's communication processor business (which this year is resulting in $36 million per quarter non-cash write offs of amortization costs, which really skews GAAP EPS downward). It was already developing its own communications processors. It also has some of the best analog radio technology in the industry. What it is doing is combining all of these functions - digital signal processing, general digital processing, and cell radio signal transmission with Wi-Fi and bluetooth. That is a killer combo. It does not mean there is no competition, or that any cell phone maker is required to adopt it. But those who do not may find themselves, in a year or two, at a severe competitive disadvantage.

Most companies that have done so well in making chips for hard-drive storage would see taking on the entire cell phone semiconductor industry as challenge enough. But not Marvell. It is also going after some other big hunks of business.

One is video processors for large screen TVs. Again, Marvell came to this game late. Again, the already have a foot in the door with some advanced silicon that makes for better pictures. Again, they are planning to solve a bunch of unsolved problems and deliver a solution that will be irresistible to the TV makers.

In parallel with that they are working on the DVD/ HD-DVD end of things as well.

Oh, and not satisfied with mere dominance in the hard drive industry, they have sunk a bunch of effort into R&D to make even better drive chips; they are confident they can gain revenues in this area.

Then there are their advance in LAN technology. And power management. And printer technology. I'm probably missing something, but that seems to cover the basics.

After a year in which Marvell and many other semiconductor makers got hit by inventory adjustments, slowed demand growth, and pricing pressure, Marvell's intense pursuit of new markets may be bearing fruit. Management believes Q3 revenues may come in around $710 million, up $53 million sequentially from Q2. I'll be very impressed if that happens.

More important, if they are right about design wins they are getting this year leading to significant new revenues in calendar 2008, I can't wait to see what Marvell looks like a year from now.

As to pricing the stock, you'll just have to choose your theory. I don't believe in buying stocks with high PE ratios, and right now if you use the GAAP numbers the PE ratio of Marvell is infinite. If you use non-GAAP numbers, it is pretty high. On the other hand I understand the value of R&D. Another company, trying to please short term investors, could have simply cut back its R&D budget in Q2 and shown some very impressive results. But as a long-term investor I'd rather have the company with the bad short term results, especially when its R&D arm has a record of paying off, as Marvell's has.

Right now I already own as much Marvell stock as my portfolio model allows, so I won't be buying more anytime soon. Even holding it at this level involves risk: just because Marvell is spending money on R&D does not mean it can sell any resulting technology. But that is a risk I can live with.