The age of AI is officially here and announced itself in the form of Nvidia’s explosive Q1 earnings. Quarters like this don’t happen very often, especially not at this scale. Their forecast of $11B in sales for Q2 was 50% above analyst estimates: an extra $4B in revenue along with expectations of record-high 70% gross margins. A 57% increase quarter-over-quarter. I’m overusing italics at this point but it’s hard to overstate just how mind-blowing these numbers are.

Guess the earnings release date!

Oh, yeah… and some other stuff happened:

Business Updates

AMD

A good, if unspectacular quarter, beating both top and bottom-line expectations ($5.4B in revenue, $0.60 earnings per share) with some weakness in gaming revenue and decreasing gross margins (down to 50% from 53% in the year-ago quarter). This in combination with a slightly weaker than expected Q2 forecast resulted in a small one-day drop in share price, before the market remembered that literally any business associated with AI is destined to be a 10-bagger by the end of the year. In all seriousness, despite Nvidia’s imperious AI positioning, AMD do appear well-placed to hoover up their left-overs as Big Tech scrambles to purchase as many GPUs as possible. (Elon Musk, in the process of building his own AI company, commented last week that GPUs are “at this point considerably harder to buy than drugs”).

To execute our broad AI strategy and significantly accelerate this key part of our business, we brought together multiple AI teams from across the company into a single organization under Victor Peng. The new AI group has responsibility for owning our end-to-end AI hardware strategy and driving development of a complete software ecosystem, including optimized libraries, models and frameworks spanning our full product portfolio. - Lisa Su, CEO, Q1 2023 earnings call.

The software ecosystem news is a welcome update, as AMD’s ROCm platform has been playing catch-up to Nvidia’s equivalent, CUDA, for years and apparently still remains some way behind in terms of usability - hopefully the new strategy bears fruit!

Su also mentioned the upcoming MI300 APU (a combination of CPU and GPU on one chip), a key part of AMD’s roadmap to address the power-efficiency bottleneck which has slowed Moore’s Law in recent years:

MI300 is actually very well positioned for both HPC sort of supercomputing workloads as well as for AI workloads. And with the recent interest in generative AI, I would say the pipeline for MI300 has expanded considerably here over the last few months, and we’re excited about that.

And:

So I think from an MI300 standpoint, that we do believe that we will start ramping revenue in the fourth quarter with cloud AI customers and then it will be more meaningful in 2024.

[AMD Q1 23 Data Centre.png] The substantial drop in Data Center margins is a result of significant increases in networking and AI investment

At the J.P. Morgan conference later in the month, there were a couple of interesting notes:

  • Approaching 30% market share in the server market.
  • PC business has gone through one of the worst down cycles since 1995 but now appears to have bottomed.

AMD’s in a strange place in the portfolio currently. It stands to benefit from the tidal wave of AI demand but this is likely a story that plays out over several years - how much of this has already been assumed in the stock price? As it stands, on a price/earnings multiple it’s valued similarly to Nvidia but without carrying the distinction of being the primary chip-making AI beneficiary. Still, it provides exposure to the trend, and with AMD due to set out their AI strategy on June 13th, I don’t intend to bet against Lisa Su’s track record.

Twilio

Continuing the could-have-been-better theme, Twilio turned in a perfectly respectable quarter combined with a sub-par Q2 forecast. On the whole though, largely ok. Unfortunately with the expiration date of his super-majority voting shares rapidly approaching (23rd June), CEO, Jeff Lawson, was in need of a somewhat more robust set of results:

While restructuring costs meant that non-GAAP operating margin was (positive!) 10%, dollar-based net expansion continued its fall to record lows (106%) and revenue guidance for Q2 is just 4-5% growth year-over-year.

I’d say on the communications side, it’s a combination of macro, some tough comparisons on the software side, it’s a mix of our efforts to rebuild plus the macro, and we factored all of this into our guide - Aidan Viggiano, CFO, Q1 2023 earnings call

This was touched on again at the J.P. Morgan conference. In addition to macro, Jeff Lawson also highlighted the impact of crypto business vanishing:

And to have an industry that represents 3% of revenue, just completely implode over the course of 6 months, like, obviously, that sucks and that’s going to present a headwind for you, which we’re certainly seeing.

There was a sliver of silver lining though, when discussing the communications side of the business (85% of revenue):

We’re not losing to competitors. We’re not seeing price erosion or anything like that. In fact, if anything, we look at our publicly traded comps, we are much larger and growing faster in terms of our Q2 guide or Q1 results than anyone else out there.

Despite this, the general feeling as I read through the quarter and conference was one of too little, too late. Twilio has been one of the worst offenders in the software space when it comes to egregious stock-based compensation. As a company that had never turned profitable pre-rate rises, investors understandably ran out of patience when there was no sign of any change and the recent reorganisation plan has arrived far too late. The case for investment hinges on the events that follow the expiration of the Class B shares in June.

And just in time for publication… shares have now risen by 10% over the past 2 days, following the news that activist investors have met with Twilio’s board, “urging them to make changes to the board and consider divestitures, among other moves.” Things are in motion…

Datadog

Man’s best friend delivers again! Revenue guidance for the full year was raised by $10 million and non-GAAP operating income by $40 million. Application Performance Monitoring (APM) and log management are now delivering $1B in annual recurring revenue (ARR) of ~$2B total ARR (out of a total of 17 separate products).

As with Twilio, sizeable chunks of revenue delivered by crypto companies this time last year have all but disappeared:

There was also a notable blip this quarter: a global outage in March that resulted in $5M of lost revenue and required “3 shifts of 500 to 600 engineers” to resolve. Pomel doesn’t see any long-term impact, although judging from the linked article Pomel’s claim that “we’ve handled it by being very transparent with our customers” doesn’t quite stack up.

Separately, he laid out the implications of AI adoption for Datadog:

our job is to help our customers absorb the complexity of the applications they’ve built so they can understand and modify them, run them, secure them. And we think that the more productivity there is, the more people can write in the amount of time. The less they understand the software they produce and the more they need us, the more value it sends our way.

And discussed copilots:

So they’re very, very good for solving a small problem, but they don’t help you build consistent code bases or didn’t help you build software platforms like that, that is still out of reach.

While Datadog’s stock is close to as low a NTM EV/S multiple as it has had as a public business, there are still significant growth expectations built into the price, so I’m erring on the side of keeping a small position for now.

Snowflake

Speaking of significant growth expectations…

Snowflake turned in a mixed quarter, with the market focussing on the lowered full year revenue guidance (forecast at 40% YoY last quarter, now down to 34%). Product gross profit margins came down to 71%, free cash flow margins rose to (an obscene) 45% and product revenue fell to 50%. YoY. Net revenue retention remained best-in-class at 151%.

Q1 is always a challenging bookings quarter, and the current macro environment, magnifies that, but we are still not satisfied with our results. We will only invest in areas that yield returns. For that reason, we will prioritize existing sales resources to drive growth before we onboard new capacity.

we literally saw 4 weeks in April where there was no week-over-week growth per se or not material. And we do think that was driven a lot by some of these customers. That’s when it happened, some of these big optimizations on storage retention policies.- Mike Scarpelli, CFO, Q1 2023 prepared remarks

Disappointing, but a far more measured response to bringing down full year expectations versus Cloudflare’s last month.

[Snowflake FCF.png] The Q1 2022 FCF margin guide for the full year was 16%. Actual: 37%. This year the guide is for 26%… Source: Q1 Earnings Presentation

Aside from the forecast, the biggest news is the acquisition of Neeva, a search business that was one of the first to implement generative AI into its results.

Engaging with data through natural language is becoming popular with advancements in AI. This will enable Snowflake users and application developers to build rich search-enabled and conversational experiences. We believe Neeva will increase our opportunity to allow non-technical users to extract value from their data. - Frank Slootman, CEO, Q1 2023 prepared remarks

From the Q&A:

I would caution you, this is not at all about natural language interfaces. A lot of the intelligence that we’re talking about is going to be manifested through the interfaces, not just through natural language.

Snowflake is in a very interesting spot. Like Datadog, there is a lot of growth built into the current price but with the long-term tailwind of increasing data proliferation across all business sectors (likely to be given a boost by AI), and with Slootman and Scarpelli - executive titans of the software world with gigantic reputations at stake - at the helm, I’m keeping a smallish position for now.

YTD return vs benchmarks

(Index source: Koyfin)

Portfolio Nasdaq S&P 500 FTSE 100
33.72% 30.30% 8.86% 4.08%

Portfolio

Holding Ticker(s) Weighting (%)
Nasdaq 100 Tracker XNAQ 29.4
Alphawave AWE 9.2
Twilio TWLO 6.2
Crowdstrike CRWD 5.7
Snowflake SNOW 4.7
Adobe ADBE 3.7
Datadog DDOG 3.7
Team17 TM17 3.2
AMD AMD 3.1
Amazon AMZN 1.5
Cash - 29.4

Adjustments

After Alphawave’s audited results were released mid-month (revenue revised downwards slightly, but FCF remained unchanged), and shares marched upwards in the footsteps of Nvidia following resumption of trading, I decided to trim my position to a more appropriate size given the questions raised over management in the past few weeks. The only other changes were to add to Twilio after the stock was hammered following earnings, selling out of Cloudflare after their poor Q1 and adding a new position, Team17, which I’ll cover next month.

Closing Remarks

Next month’s update:

  • Crowdstrike’s Q1
  • Adobe’s Q2

Until next time!